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CHAPTER 12

TRADING ACCOUNT

At the end of the year it is necessary to ascertain the net profit or the net loss. For this purpose, it is first necessary to know the gross profit or gross loss. Gross Profit is the difference between the selling price and the cost of the goods sold.

Trading Account is one of the financial statements which shows the result of buying and selling of goods and/or services during an accounting period. After the preparation of trial balance, the next step is to prepare Trading Account. The main objective of preparing the Trading Account is to ascertain gross profit or gross loss during the accounting period. Gross Profit is said to have made when the sale proceeds exceed the cost of goods sold. Conversely, when sale proceeds are less than the cost of goods sold, gross loss is incurred.

For the purpose of calculating cost of goods sold, we have to take into consideration opening stock, purchases, direct expenses on purchasing or manufacturing the goods and closing stock. The balance of this account i.e. gross profit or gross loss is transferred to the Profit and Loss Account. The specimen of a Trading Account is given below:

SPECIMEN OF TRADING ACCOUNT

The original page presents this as a two-sided Trading Account, with the debit side containing Opening Stock, Purchases, Purchase Returns, Direct Expenses and Gross Profit, and the credit side containing Sales, Sales Returns, Closing Stock and Gross Loss.

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Important terms regarding trading account

Stock

The term ‘stock’ includes goods lying unsold on a particular date. The stock may be of two types:

(a) Opening stock

(b) Closing stock

Opening stock refers to the closing stock of unsold goods at the end of previous accounting period which has been brought forward in the current accounting period. This is shown on the debit side of the Trading Account.

Closing stock refers to the stock of unsold goods at the end of the current accounting period. Closing stock is valued either at cost price or at market price whichever is less. Such valuation of stock is based on the principle of conservatism which lays down that the expected profit should not be taken into account but all possible losses should be duly provided for.

Adjusted Purchases and Closing Stock

Sometimes the Closing Stock may be given in the Trial Balance itself. This would mean that both the Opening and the Closing Stocks have been adjusted in the Purchases. In such a situation, the Opening Stock will not appear in Trial Balance. The Trial Balance will show only the figures of Adjusted Purchases and Closing Stock.

The Adjusted Purchases are in fact the Cost of Goods Sold. They have been worked out by adding the Opening Stock + Net Purchases + Direct Expenses – Closing Stock.

The Adjusted Purchases are shown on the debit side of “Trading Account”.

Points to Remember: -

 The opening inventory and purchases are written on the debit side.

 Sales and the closing inventory are entered on the credit side.

 Ifthereareanydirectexpensesthentheyshouldalsobewrittenonthedebit sideoftheTrading account.

 Ifthe balance of credit side is more,the difference is written on the debit side as gross profit. This amount will also becarried forward to the Profit and Loss Account on the credit side.

 Incaseofgrossloss,i.e.,whenthedebitsideoftheTradingAccountexceedsthecreditside,the amountwillbewrittenonthecreditsideoftheTradingAccountandtransferredtothedebitside ofthe Profit and Loss Account.

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In such a situation there is no need to show “Closing Stock in the Trading Account” as it already stands adjusted in Purchases. It will be shown only on the “Assets side of Balance Sheet”

Crux: If Closing Stock appears in the Trial balance:-

The closing inventory is then not entered in the trading account, it is shown only in the balance sheet. This is because it has already been adjusted to arrive at Cost of Goods Sold.

Purchases

Purchases refer to those goods which have been bought for resale. It includes both cash and credit purchases of goods.

The following items are shown by way of deduction from the amount of purchases:

(a) Purchases Returns or Return Outwards.

(b) Goods withdrawn by proprietor for his personal use.

(c) Goods distributed by way of free samples.

(d) Goods given as charity.

Direct Expenses

Direct expenses are those expenses which are directly attributable to the purchase of goods or to bring the goods in saleable condition.

Some examples of direct expenses are as under:

(a) Carriage Inward.

(b) Freight and insurance.

(c) Wages.

Sales

Sales include both cash and credit sales of those goods which were purchased for resale purposes.

Some customers might return the goods sold to them (called sales return) which are deducted from the sales in the inner column and net amount is shown in the outer column.

While ascertaining the amount of sales, the following points need attention:

(a) If a fixed asset such as furniture, machinery etc. is sold, it should not be included in sales.

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(b) Goods sold on consignment or on hire purchase or on sale or return basis should be recorded separately.

(c) If goods have been sold but not yet despatched, these should not be shown under sales but are to be included in closing stock.

(d) Sales of goods on behalf of others and forward sales should also be excluded from sales.

YouTube Link for Lecture:

Channel Name:

Lateef’s Commerce Academy

Page number: 51

Visual content in the PDF

The principal visual element is the Specimen of Trading Account on page 48. It is arranged in two columns/sides:

Debit side:

• To Opening Stock

• To Purchases

• Less: Purchase Returns

• To Direct Expenses

  • Carriage Inward

  • Wages

  • Fuel, Power and Lighting Etc

• To Gross Profit transferred to P & L A/c

Credit side:

• By Sales

• Less: Sales Returns

• By Closing Stock

• By Gross Loss transferred to P & L A/c

The text also gives the Cost of Goods Sold / Adjusted Purchases relationship as:

Opening Stock + Net Purchases + Direct Expenses – Closing Stock.