trading account
As already discussed, the first section of the trading and profit and loss account is called the trading 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.
Business account preparation
The trading account is mainly prepared to find out 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 the gross profit, it is necessary to know:
(a) cost of goods sold.
(b) dirty.
Total sales can be determined from the sales ledger. However, the cost of goods sold is calculated. To calculate the cost of sales it is necessary to know its meaning. ‘Cost of goods’ includes the purchase price of the goods plus expenses associated with purchasing the goods and moving the goods to the place of business. To calculate the cost of goods, we must deduct from the total cost of goods purchased the cost of goods on hand. We can study this phenomenon with the help of the following formula:
Initial stock + cost of purchases – closing stock = cost of sales
As already discussed, the purpose of preparing a business 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) – (Starting Stock + Purchases + Direct Expenses)
Opening stocks and purchases, along with purchase and delivery expenses (direct expenses), are recorded as a debit, while sales and ending stocks are recorded as a credit. If the credit side is better than the debit side, the difference is written to the debit side as gross profit, which is ultimately 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 that is recorded on the credit side and ultimately shown on the debit side of the profit and loss account.
Common elements in a business account:
A) Flow side
1. Initial stock. It is the stock that remained unsold at the end of the previous year. It must have been brought to the books with the help of the opening entry; so it always appears within the trial balance. It is usually shown as the first item on the debit side of the business account. Of course, in the first year of a business there will be no starting stock.
2. Shopping. It is normally the second item on the debit side of the trading account. ‘Purchases’ means total purchases, ie purchases in cash plus credit. Any return abroad (return of purchases) 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 purchase account and credit the vendor account with the cost of goods.
3. Purchase expenses. All expenses related to the purchase of goods are also charged to the trading account. These include wages, inland freight, tariffs, clearance charges, port charges, excise duties, attribution and import duties, etc.
4. Manufacturing Expenses. Entrepreneurs incur such expenses to make or leave the goods in a salable condition, namely, motive power, gas fuel, shops, royalties, factory expenses, salary of foreman and supervisor, etc.
Although the manufacturing expenses should be taken strictly in the manufacturing account, since we are preparing only a business account, expenses of this type can also be included in the business account.
(B) Credit side
1. Dirty. Sales means total sales, that is, cash sales plus credit. If there are sales returns, they must be deducted from sales. Then, the net sales are credited to the business account. If a business asset has been sold, it should not be included in the sales.
2. Closing stock. It is the value of the stock that remains unsold in the store or store on the last date of the accounting period. Normally, the closing stock is given outside of the trial balance, in that case, it is shown on the credit side of the trading account. But if it is given within the trial balance, it should not be shown on the credit side of the trading account, but instead appears only on the balance sheet as an asset. Closing inventories should be valued at cost or market price, whichever is lower.
Valuation of closing stock
To determine the value of the closing stock, it is necessary to make a complete inventory or list of all items owned by God along with the quantities. On the basis of physical observation, stock lists are prepared and the total stock value is calculated on the basis of unit value. Therefore, it is clear that inventory involves (i) inventory, (ii) pricing. Each item has a cost price, unless the market price is lower. Pricing an inventory at cost is easy if the cost remains fixed. But prices keep fluctuating; therefore, stock valuation is done on the basis of one of many valuation methods.
The preparation of the commercial account helps the merchant 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: one arrives at:
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 belonging to the commercial account
For the transfer of various accounts related to goods and purchase expenses, the following closing entries are recorded:
(i) For opening actions: debit business account and credit actions account
(ii) For purchases: debit trade account and credit purchase account, the amount being the and the amount once purchase returns have been deducted.
(iii) For purchase returns: debit purchase return account and credit purchase account.
(iv) For inward returns: sales debit account and credit sales return account
(v) For direct expenses: Debit of the trading account and credit of the direct expense accounts individually.
(vi) For sales: sales debit account and credit trading account. We will find that all the accounts as mentioned above will be closed with the exception of the trading account
(vii) For Closing Actions: Debit Closing Action Account and Credit Trading Account After recording the above entries, the trading account will be balanced and the difference of two sides will be determined. If the credit side is more, the result is the gross profit for which the next entry is recorded.
(viii) For gross profit: debit trading account and credit profit and loss account. If the result is 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 profit (or added to gross loss), the resulting figure will be net profit or net loss.
Expenses that are recorded in the profit and loss account are called ‘indirect expenses’. These will be classified as follows:
Selling and distribution expenses..
These include the following expenses:
(a) Salary and commission of sellers.
(b) Commission to agents
(c) Freight and transportation in sales
(d) Sales tax
(e) Bad debts
f) Advertising
g) Packaging costs
h) Export duties
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) Mail and telegrams
k) Bank charges
Financial expenses
These included:
(a) Discount allowed
(b) Interest on Capital
(c) Interest on loans
(d) Discount charges on the discounted invoice
Maintenance, Amortizations and Provisions etc..
These include the following expenses
(a) Repairs
(b) Depreciation of assets
(c) Provision or reserve for bad debts
(d) Reserve for discount to debtors.
Along with the indirect expenses above, the debit side of the profit and loss account also comprises various business losses.
On the credit side of the profit and loss account, the items recorded are:
(a) Discount received
(b) Commission received
(c) Income received
(d) Interest received
(e) Investment income
(f) Gains on sale of assets
(g) Recovery of bad debts
(h) Dividend received
(i) Premium Learning, etc.