Trading account is the comparison of sales and purchase. This account is prepared to determine the amount of gross profit or gross loss on sales. Trading account is prepared to know the trading result. Trading result indicates gross profit or loss of the trading period. Gross profit or loss is the difference between selling price and purchase price of the goods sold. If selling price of the goods sold is more than the purchase price, the difference is known as gross profit. On the contrary, when the situation is reverse, the difference is termed as gross loss. Here, purchase price includes the cost of shipment and other direct expenses incurred until the goods reach the point of sale and to make the goods ready for sale, if any. The proforma of Trading Account is given.
Notes Proforma of Trading Account
In the Books of ………. Trading Account
(for the year ending ……….)
Particulars Amount (Dr.) ( ) Particulars Amount (Cr.) ( ) To Opening Stock To Purchases --- Less: Returns --- To Wages & Salaries
To Carriage Inwards To Cartage
To Frieght
To Light Power & Heating in factory
To Factory Insurance To Works Manager’s Salary To Foreman’s Salary To Factory Rent & Taxes To Motive Power To Factory Repairs To Factory Expenses To Octroi duty To Custom Duty To Manufacturing Exps. To Consumable Stores To Gross Profit Transferred to P/L A/c --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- By Sales --- Less: Returns --- By Closing stock
By Gross Loss (if any) Transferred to P/L A/c --- --- --- --- --- Notes
There is no particular proforma of the Trading Account. The above proforma given is traditional one. That is not as per law. Here the students are advised to follow this proforma.
If the total of credit side is more than the total of debit side, difference is called gross profit or vice versa gross loss.
Gross Profit: After showing all the items of debit side and credit side, each side is totalled. If the
total of credit side is higher than the total of debit side, the difference is termed as Gross Profit. In case of reverse situation i.e. debit side is higher than the credit side, it is a Gross Loss. Though the gross profit or gross loss is not a real profit or real loss that is why it is taken to Profit & Loss account from where Net Profit or Net Loss is calculated.
Notes Following are the main points of difference between gross profit and net profit.
Gross Profit Net Profit
It is the excess of net sales over cost of purchase or manufacture (all expense relating to purchase or manufacture of goods) of goods.
It is the excess of gross profit over all indirect expenses.
It is not true profit of the business. It is true profit of the business.
It shows credit balance of the trading account It shows credit balance of the profit and loss account.
The progress of the business can be judged by the comparison of gross profit with net sales
The profitability of the business can be measured by the comparison of net profit with net sales.
Detailed Study of Different Items Appearing in Trading Account
1. Opening Stock: Whenever Trading account is prepared, stock of the last year is shown as
opening stock of the current year, which is passed through an opening entry and appears in the trial balance. It is generally shown as a first time in the Trading account but if the business is a new one, just started, then there would not be any opening stock. In case of a trading concern finished goods is the only item which is available for sale whereas in case of a manufacturing concern, opening stock is of: (a) Raw Materials, (b) Finished Goods, and (c) Semi-finished Goods.
Following entries are passed in books of the business:
For Adjustment of Opening Stock
S. No. Particulars L.F. Amount (Dr.)
( )
Amount (Cr.) ( )
1. Purchases A/c Dr.
To opening stock A/c (Adjustment for opening stock)
For Adjustment of Closing Stock
S. No. Particulars L.F. Amount (Dr.)
( )
Amount (Cr.) ( )
2. Closing stock A/c Dr.
To purchases A/c (Adjustment for closing stock)
Note Thus, there will be no opening stock in the trial balance because of the above adjustment for opening stock and amount of adjusted purchases is to be shown on the debit side of trading account and amount of closing stock on the assets side of the Balance sheet.
2. Purchases are shown in the trial balance: It is the sum of cash purchases + credit purchases.
The balance of Purchases A/c is always debit balance and if there is any return to be shown by purchases returns (returns - outwards) A/c, which is having a credit balance, must be deducted from the total purchases in order to arrive at the correct figure of Net Purchases.
Notes Thus in Trading account purchases returns are shown by way of deduction from the
purchases as follows:
( )
Total purchases as per trial Balance 1,00,000
–Total Returns –3,000
97,000 Sometimes it happens that the goods are received but invoice is not received that is why it is not entered in the purchases A/c. In such a case, a closing entry at the end of the year must be passed which is as follows:
Purchases A/c Dr.
To Supplier A/c (Goods received entered)
If any purchase is made by the proprietor for his /her personal use, then it must also be deducted from total purchases. Sometimes if the delivery of goods is to take place in future under a contract of Business, such goods must not be included in the total purchases.
3. Direct Expenses: The expenses, which are incurred on acquiring goods for resale purposes
are termed as direct expenses which are shown on the debit side of the Trading account. Such expenses, might have been paid or outstanding or paid in advance, the net amount is shown in the trading account. Such expenses are:
(a) Carriage Inwards: The expenses which are incurred for bringing goods in the business for resale purposes are called carriage inwards. Such items of expenses are shown on the debit side of the Trading account. If carriage is paid for bringing any asset in the business such as Plant/Machinery is not shown in the Trading account, but is added in the cost of the asset.
(b) Wages on Purchases: If any wage is paid for making or manufacturing as article or on goods meant for resale is a direct expenses and is shown on the debit side of the trading account whereas if wages are paid for bringing any asset such as plant etc. is not a direct expense and is added in the cost of the plant. Similarly, if wages are paid after the goods are sold, it is unproductive wages, hence to be shown in the profit & loss A/c.
(c) Freight on Purchases: When freight is paid or is payable on the goods purchased for resale, it is a direct expense and is shown to the debit side of the Trading A/c but if any freight is paid on the purchase of an asset, then it is added in the cost of the asset.
(d) Other direct Expenses: Such as:
(i) Fuel, lighting, power: Generally goods are manufactured with the help of coal, or power/electricity and lighting for the factory. Such expenses are also direct expenses, and are shown on the debit side of the Trading account. (ii) Octroi duty, custom etc.: Whenever goods are purchased from outside,
municipality (Municipal Corporation) charges some tax, known as octroi which is direct expenses to be debited in the Trading account. Similarly, when Goods are purchased from abroad or foreign countries. Import duty is to be paid which is also a direct expense and to be shown in Trading account but if the asset such as plant/machinery is purchased and import duty is paid then it is added in the cost of plant/machinery.
Notes (iii) Packing expenses which are incurred for packing the goods for resale, are direct expenses and to be shown in Trading account, but if packing is done for sending goods to the customer’s address, such expenses are realized from the customers, hence are not direct expenses.
4. Sales: Total amount of sales, cash sales and credit sales, is shown on the credit side of the
trading account and if there is any sales-return (return inwards) is to be deducted from such sales.
Notes
1. If some assets is sold then it is not a revenue receipt but it is a capital receipt to be shown by way of deduction from total assets.
2. Sometimes sales had taken place, but goods are not delivered, then such goods should not be included in the closing stock but be kept separately.
3. Similarly goods are sent on consignment or sale or return basis or hire purchase basis, cannot be included in the sales because the buyer is free to return.
5. Closing Stock: The second item of the credit side of trading account is the closing stock.
The goods which could not be sold during a fixed period, are termed as closing stock. This item is not shown in the trial balance because its valuation is done at the end after closing of all the accounts. That is why it is shown as a footnote beneath the trial balance, but when purchases are adjusted with opening and closing stock, then the balance of closing account is debit, hence it is shown as an asset in the Balance Sheet. Valuation of closing stock poses a number of problems such as cost price or market price, but as per convention stock is always valued at cost or market price whichever is less. This rule is based on the principle of probable losses which are taken into account, but not the probable gains. It is also necessary to be careful while valuing closing stock correctly. Otherwise gross profit, thus ascertained, would not be correct one, if it is not followed strictly then the Gross profit would be incorrect and misleading. Journal entries to be passed for closing stock & opening stock.
S. No. Particulars L.F. Amount (Dr.)
( )
Amount (Cr.) ( )
(i) Closing stock A/c Dr.
To trading A/c
(Closing stock shown on the credit side of Trading A/c)
(ii) if closing stock A/c Dr. To purchases A/c
(If closing stock is transferred to purchases A/c, then it cannot be shown in the trading A/c, but to be shown in the Balance Sheet only.)
(iii) Trading A/c Dr.
To opening stock (Opening stock transferred)
Notes