# Trading and Profit and Loss Account

As already discussed, first section of trading and profit and loss account is called trading account. The aim of preparing trading account is to find out gross profit or gross loss while that of second section is to find out net profit or net loss.

Trading account is prepared mainly to know the profitability of the goods bought (or manufactured) sold by the businessman. The difference between selling price and cost of goods sold is the,5 earning of the businessman. Thus in order to calculate the gross earning, it is necessary to know:

(a) cost of goods sold.

(b) sales.

Total sales can be ascertained from the sales ledger. The cost of goods sold is, however, calculated. n order 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 expenses relating to purchase of goods and brining the goods to the place of business. In order to calculate the cost of goods " we should deduct from the total cost of goods purchased the cost of goods in hand. We can study this phenomenon with the help of following formula:

Opening stock + cost of purchases - closing stock = cost of sales

As already discussed that the purpose of preparing trading account is to calculate the gross profit of the business. It can be described as excess of amount of 'Sales' over 'Cost of Sales'. This definition can be explained in terms of following equation:

Gross Profit = Sales-Cost of goods sold or (Sales + Closing Stock) -(Stock in the beginning + Purchases + Direct Expenses)

The opening stock and purchases along with buying and bringing expenses (direct exp.) are recorded the debit side whereas sales and closing stock is recorded on the credit side. If credit side isJeater than the debit side the difference is written on the debit side as gross profit which is ultimately recorded on the credit side of profit and loss account. When the debit side exceeds the credit side, the difference is gross loss which is recorded at credit side and ultimately shown on the debit side of profit & loss account.

Usual Items in a Trading Account:

A) Debit Side

1. Opening Stock. It is the stock which remained unsold at the end of previous year. It must have been brought into books with the help of opening entry; so it always appears inside the trial balance. Generally, it is shown as first item at the debit side of trading account. Of course, in the first year of a business there will be no opening stock.

2. Purchases. It is normally second item on the debit side of trading account. 'Purchases' mean total purchases i.e. cash plus credit purchases. Any return outwards (purchases return) should be deducted out of purchases to find out the net purchases. Sometimes goods are received before the relevant invoice from the supplier. In such a situation, on the date of preparing final accounts an entry should be passed to debit the purchases account and to credit the suppliers' account with the cost of goods.

3. Buying Expenses. All expenses relating to purchase of goods are also debited in the trading account. These include-wages, carriage inwards freight, duty, clearing charges, dock charges, excise duty, octroi and import duty etc.

4. Manufacturing Expenses. Such expenses are incurred by businessmen to manufacture or to render the goods in saleable condition viz., motive power, gas fuel, stores, royalties, factory expenses, foreman and supervisor's salary etc.

Though manufacturing expenses are strictly to be taken in the manufacturing account since we are preparing only trading account, expenses of this type may also be included in the trading account.

(B) Credit Side

1. Sales. Sales mean total sales i.e. cash plus credit sales. If there are any sales returns, these should be deducted from sales. So net sales are credited to trading account. If an asset of the firm has been sold, it should not be included in the sales.

2. Closing Stock. It is the value of stock lying unsold in the godown or shop on the last date of accounting period. Normally closing stock is given outside the trial balance in that case it is shown on the credit side of trading account. But if it is given inside the trial balance, it is not to be shown on the credit side of trading account but appears only in the balance sheet as asset. Closing stock should be valued at cost or market price whichever is less.

Valuation of Closing Stock

The ascertain the value of closing stock it is necessary to make a complete inventory or list of all the items in the god own together with quantities. On the basis of physical observation the stock lists are prepared and the value of total stock is calculated on the basis of unit value. Thus, it is clear that stock-taking entails (i) inventorying, (ii) pricing. Each item is priced at cost, unless the market price is lower. Pricing an inventory at cost is easy if cost remains fixed. But prices remain fluctuating; so the valuation of stock is done on the basis of one of many valuation methods.

The preparation of trading account helps the trade to know the relationship between the costs be incurred and the revenues earned and the level of efficiency with which operations have been conducted. The ratio of gross profit to sales is very significant: it is arrived at :

Gross Profit X 100 / Sales

With the help of G.P. ratio he can ascertain as to how efficiently he is running the business higher the ratio, better will be the efficiency.

Closing Entries pertaining to trading Account

For transferring various accounts relating to goods and buying expenses, following closing entries recorded:

(i) For opening Stock: Debit trading account and credit stock account

(ii) For purchases: Debit trading account and credit purchases account, the amount being the et amount after deducting purchases returns.

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

(iv) For returns inwards: Debit sales account and credit sales return account

(v) For direct expenses: Debit trading account and credit direct expenses accounts individually.

(vi) For sales: Debit sales account and credit trading account. We will find that all the accounts as mentioned above will be closed with the exception of trading account

(vii) For closing stock: Debit closing stock account and credit trading account After recording above entries the trading account will be balanced and difference of two sides ascertained. If credit side is more the result is gross profit for which following entry is recorded.

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

Profit and Loss Account

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

For earning net profit a businessman has to incur many more expenses in addition to the direct expenses. Those expenses are deducted from profit (or added to gross loss), the resultant figure will be net profit or net loss.

The expenses which are recorded in profit and loss account are ailed 'indirect expenses'. These be classified as follows:

Selling and distribution expenses.

These comprise of following expenses:

(a) Salesmen's salary and commission

(b) Commission to agents

(c) Freight & carriage on sales

(d) Sales tax

(g) Packing expenses

(h) Export duty

These include:

(a) Office salaries & wages

(b) Insurance

(c) Legal expenses

(e) Rates & taxes

(f) Audit fees

(g) Insurance

(h) Rent

(i) Printing and stationery

(j) Postage and telegrams

(k) Bank charges

Financial Expenses

These comprise:

(a) Discount allowed

(b) Interest on Capital

(c) Interest on loan

(d) Discount Charges on bill discounted

Maintenance, depreciations and Provisions etc.

These include following expenses

(a) Repairs

(b) Depreciation on assets

(c) Provision or reserve for doubtful debts

(d) Reserve for discount on debtors.

Along with above indirect expenses the debit side of profit and loss account comprises of various business losses also.

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

(e) Income from investments

(j) Profit on sale of assets

Preparation of Profit and Loss Account

As already stated profit and loss account is commenced with gross profit or gross loss as ascertained by trading account. Then the profit and loss account is debited with all indirect expenses and losses. This results in closing of indirect expenses and losses account. The profit and loss account is then credited with various incomes and gains accounts by which all these accounts are closed.

Explanation of Certain items of Profit and Loss Account

1. Salaries

Salaries are paid for the services of employees and are debited to profit and loss ac- count being indirect expense. If any salary has been paid to proprietor or partners, it should be shown separately because it requires special treatment at the time of income tax assessment.

2. Salaries and Wages

When wages account is included with salaries it treated is as indirect expense and is taken into profit and loss account.

3. Rent

Rent of the office shop showroom or godown is an indirect expense and so is debited to profit & loss account. However, rent of factory is debited to trading account. When a part of the building has been sublet the rent received should be shown on the credit side of profit and loss account as a separate item.

4. Rates and Taxes

These are levied by the local authorities to meet public expenditure. It being an indirect expenditure is shown on the debit side of profit and loss account.

5. Interest

Interest on loan, overdraft or overdue debts is payable by the firm. It is an indirect expense; so debited to profit and loss account. Interest on loan advanced by the firm on depositor investments is an income of the firm and so is credited to the profit and loss account.

If business has paid any interest on capital to its proprietor or partners it should also be debited in the profit and loss account but separately because this item needs special treatment at the time of income-tax assessment.

6. Commission

In business sometimes agents are appointed to effect sales, who are paid commission as their remuneration. So this being a selling expenses is shown on the debit side of profit and loss account. Sometimes commission is also paid on purchases of goods, such 'as expense should be debited in the trading account. Sometimes the firm can also act as an agent to the other business houses and in such cases it receives commission from them. Commission so received is shown on the credit side of profit and loss account.

They are also termed as 'sundry expenses'. Trade expenses represent expenses of such a nature for which it is not worthwhile to open separate accounts. Trade expenses are not taken to trading account.

8. Repairs

Repairs to the plant, machinery, building are indirect expenses are treated expense and are debited to profit and loss account..

9. Traveling Expenses

Unless mentioned otherwise, traveling expenses are treated as indirect expenses and are debited to profit and loss account.

10. Horse & stable Expentses

Expenses incurred for the fodder of horses and wages paid for looking after stable are treated as indirect expenses and debited to profit and loss account.

This is the amount charged from persons to whom training is imparted by the business. It is an income and is credited to profit and loss account. In case apprentice premium is charged in advance for two or three years, then the amount is distributed over number of years and each year's profit and loss account is credited with its share of income.

It is the amount which could not be recovered by the trader on account of credit sales. It is a business loss, so is debited in the profit and loss account.

If the premium is paid on the life policy of the proprietor of the business; it is treated as his drawings and is shown by way of deduction from the capital account. It should not be taken to profit and loss account.

If insurance premium account appears in the trial balance, it stands for the insurance of the business. This is taken to profit and loss account. Insurance premium on goods purchased, factory building, factory machines are treated as direct expense and are taken to trading account.

15. Income Tax

In the case of merchant income-tax paid is treated as a personal expense and is shown by way of deduction from capital account. Income-tax in case of companies is treated differently.

Discount is a reward for prompt payment. It is belief to show discount received and discount allowed separately on the credit and debit side of profit and loss account respectively instead of showing the net balance of this account.

17. Depreciation

Depreciation is a loss incurred on account of use of fixed assets in the business. Generally, it is charged from profit and loss account at a fixed percentage. The students should exercise great care as regards the rate of depreciation. If rate is without words 'per annum', then the rate will be taken irrespective of the period of accounts. This is very important when the period of accounts is less than one year. On the other hand, if the rate of depreciation is 'per annum' the depreciation should be calculated on the assets with due consideration to the period for which the asset has been used in business during the year. In case of additions to assets during the year, it is advisable to ignore depreciation on additions if the date of additions is not given. Same rule shall hold good for the sale of assets during the year.

18. Stock at the end appearing in the trial balance.

It is important to emphasize the rule that balance appearing in the trial balance is taken to one and only one place. It may either be trading account or profit and loss account or balance sheet. Since stock at the end is an asset, it will betaken to balance sheet. On the other hand, so long as there is stock in trade, account for that must be kept open and thus be taken to the assets side of balance sheet.

Author:.

Proprietor of HiTech Computer Services, Anil Kumar Gupta, Bachelor of Engineering (Hons.) in Electrical and Electronics Engineering from Birla Institute of Technology and Science, Pilani, India, Year of passing : May, 1985, is born on January 7, 1964 , Age : 40+, and is Indian national. Services Offered by HiTech Computer Services : Standard software for various business segments, Customized Software Development, Websites and web based ASP applications development, Financial Accounting and...

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### Have a question for Anil?

amarender
9th May 2014 3:11am
Rajesh taken 2,50,000 from bank in the form Profit? Entry for this Transaction

amar chaurasia
19th May 2014 4:57am
sir we are import goods from grish to kolkata port. so what the accounting entry of all purchase, payment by bank , profit & loss etc

MRITYUNJOY SARKAR
28th May 2014 3:01pm
PLEASE TELL ME PERCENTAGE OF GROSS PROFIT &NET PROFIT GENERALLY APPLIED IN BUILDING MATERIAL SUPPLY BUSINESS. AND ALSO TELL ME WHAT SHOULD BE PERCENTAGE OF PURCHASE,CARRIAGE IN WARD,CLOSING STOCK IN THE ABOVE BUSINESS

rizil
22nd June 2014 4:21am
the income earned through maintinance services after sales is treated as direct income or indirect income.

abdikhani ahmed
4th July 2014 5:06am
help me solve b. The following trial balance was extracted from the books of Rodney, a sole trader, at 31st December 2013; Shs Shs. Drawings/Capital 2,148 20,271 Debtors/Creditors 7,689 5,462 Purchases/Sales 62,101 81,742 Rent and Rates 880 Light and heat 246 Salaries and wages 8,268 Bad debts 247 Provision for bad debts 326 Stock in trade 31st Dec 1996 9,274 Insurance 172 General Expenses 933 Bank balances 1,582 Motor van at cost/Provision for depreciation 8,000 3,6000 Proceeds on ... Read More

abdikhani ahmed
4th July 2014 5:08am
c. H. Seamers Ltd started trading on 1 January 2011. During the two years ended 31 December 2011 and 2012 the following debts were written off to the Bad Debts Account on the dates stated: 31 August 2011 J. Otieno sh1,850 30 September 2011 D. Kimani sh2,400 28 February 2012 S. Wambua sh2,800 31 August 2012 K. Rotich sh1,600 30 November 2012 A Oliver sh 3,500 On 31 December 2011 there had been a total of debtors remaining of sh.405,000. It was decided to make a provision for ... Read More

piyush
14th July 2014 3:31am
sir, why are we deduct sales tax from P&l.

ashwani
17th July 2014 2:54pm
where we will show calls in arrear along with the balnce sheet.

Viney Kumar
5th October 2014 6:15am
Respected Sir, Generally formula for closing stock is Opening Stock+Purchases+Gross Profit-Sales. How can I apply this formula which has its first financial year means this is the new established company and has 0 opening purchases let's say rs 5000 and sales rs 2000 so i have 3000 rs as its gross profit what is its closing stock. Please Guide. I need your valuable suggestion.

shiva
25th October 2014 11:29am
sir . in trading a/c if gross loss occurs and net profit occurs appears in p&l a/c . what will happens ? y? explain

26th October 2014 10:21pm
plzzz sir explain about direct expenses with exmple

raja raman
27th October 2014 1:48pm
If opening stock is overvalued 1000 then what will be the treatment in final account

m zakir
6th November 2014 2:16am
how to treat the amount of discount in p&L ACCTS.,as interest or other finance charges?

MURARI JAIN
6th November 2014 11:39pm
RENT OF THE WORKSHOP IS TREATED FOR TRADING ACCOUNT OR P&L ACCOUNT?

18th November 2014 2:09am
can we debit the loss on sale of car in to the profit and loss account and arrive the loss of business income , the constitution being proprietory?

fareesa
26th November 2014 8:15am
reason why gross profit is shown on the debit side of the trading accont

bijay
27th November 2014 3:42pm
where does a credit purchase and credit sale are posted in final accounts?

raghvi
30th November 2014 8:08am
where power should be recorded in trade account or in profit and loss account.....

1st December 2014 9:10am
Sir. i am confused in one thing..
kindly explain me the definition of other indirect expense in Profit & Loss expenses head?. In Other Indirect expenses which terms are apply and on which base we can apply in Income Tax Return?

rinku
10th December 2014 8:36am
Treatment of Office Fixtures in final accont

rohit
17th December 2014 11:25pm
how to find ratio analysis of final account,cashflow,balance sheet of company....

Pooja
4th February 2015 2:57am
Sir I want to know where does Net loss appear in Balance Sheet. Is it to be deducted from Capital. Or should the Business entity rule be applicable.

m. arun kumar
7th February 2015 9:44am
If i purchased capital goods (vat 12.5%). This purchase was eligible to put in trading account under the head of purchase. Is it correct or not.

Annie Joyner Jyrwa
2nd March 2015 5:02am
Dr. Balances:(in Rs.) Purchases-180000,Returns inwards- 4500,Carriage on purchases-2600,Carriage on sales - 1500,Stock-32200,Cash-3000,Building-150000, Machinery-72000,Fuel and power-8500,Debtors-81500,Investments -36000,Rent-4000,General expenses(including insurance premium of Rs.2000 paid for one year ending 30th june, 2014)-15000,Wages and salaries-21000, Sales tax paid-4400, Drawings-22000. Cr. Balances:(in Rs.) Sales - 354000, Returns - 6200, Creditors - 28000, Interest on investments - ... Read More

Annie Joyner Jyrwa
2nd March 2015 5:13am
A of Surat consigns goods to B of Jaipur to be sold at or above invoice price. B is entitled to get a commission of 8% on sales at invoice price plus 25% of any surplus price realized. B accepted a bill of exchange drawn by A amounting to 50% of the invoice price. In the year 2013 goods consigned by A were invoiced at Rs.250000. These goods cost to A Rs.200000(including freight). Sales made by B during the year amounted to Rs.235000. At the end of the year goods unsold with B represented an ... Read More

Mackaina Wright
16th March 2015 1:28pm
Do you know how to get the closing stock figure at the end of the trial balance, that is written under adjustments?

CASPA
7th April 2015 6:57am
how can i post entries in trading loss account

shyamal hazra
15th April 2015 2:12am
goods not entered in 2014-15.But invoices received and entered in purchase account. I assume that there may be entry of goods in transit. pl tell me a/c entries in PL and BS and goup of related ledger a/c

usha
6th May 2015 5:22am

Sachin gopalan
3rd June 2015 10:54am

abdul shafik
21st July 2015 10:54am
how to treat audit fees in profit and loss prior to incorporation

deepak kumar
3rd August 2015 9:27am
i have been take loan form bank amount is 139909.and notice given by bank that you submit trading a/c and balance sheet in the bank in this month. so my qution is what will be precenteg of g/p and n/p

ausha
6th August 2015 12:03pm
If both opening and closing fixed assets in current liabilities 37360, clising 45000, givensnd opeing and closing cost 365000 and 430000 given,sale proceed 42500, loss on sale 33200 ,addition 225360 given,how willb ddepreciation calculated

17th August 2015 5:56pm
What are the five ledger account that are always closed to the profit and loss account and why?

Chopper
27th August 2015 10:45am
Interest on loan taken for the Car and Bikes for business smoothness. does it comes under P&L account or Capital Appropriation account???

KHUSHALRAJ SUNDESHA
2nd September 2015 6:45am
sir, which services applicable for tds/service tax in shipping services (exa: agecy charges, ocean freight,transportation,cfs charges,thc & misc charges)

Damilola Olarewaju
7th September 2015 6:18am
Pls how do i treat deposit with suppliers in trading,p&l account...is,it d same as purchases

mohd Shariq
6th October 2015 10:30pm
cost on disposal of fixed assets comes on which side of p/l ac

22nd November 2015 10:40pm
Valuable ideas . I was enlightened by the analysis - Does anyone know if my business might be able to grab a template IRS 1040 - Schedule C form to use ?

10th January 2016 1:12pm
investment sold at 10% profit on cost but entire sale proceeds have been taken as sales??

Ajitha
23rd May 2016 11:08am
What is the reason direct expences and indirect expnces are made seperately?

Aisha
7th June 2016 7:25pm
How to calculate the stock reserve percentage ratio if not given in the question

Aisha
7th June 2016 7:27pm
How to calculate the gross profit ratio i need the formula

Anjali luthra
21st June 2016 12:41pm

satnam
16th August 2016 11:23am
salary to factory manger should be treated in trading or profit and loss account ? and why?

Anshu
30th October 2016 1:09am
Where does royalty on sales go?

vijay sai
16th December 2016 6:28am
Sir,
Sometimes trade expenses shifts between p&l to trading a/c..what is the reason for shifting?

ripu singh
8th March 2017 1:49pm
Sir if accumulated depreciation is given in the trial balance so where we put that amount while preparing final accounts

Rahul kumar Kamti
11th April 2017 7:30am
the rates & taxes cover 15 month in financial year. Amount of Rates & taxes is Rs. 4800/-

Which Amount coming in financial year in P& L Account.

harih
10th May 2017 11:51pm
how to treat expenses that occured to setup the business ; ie before investing capital??

Anwuri Precious
17th May 2017 12:29pm
pls help solve this problem. Am preparing a manufacturing, trading and profit or loss statement and I don't no what to do with this:
10% of factory expenses and wages were incurred to put the goods in saleable condition

biraj pandey
7th June 2017 10:44pm
pls tell me adjusment of these items in final account ....law charge,legal charge,expenses on purchase,railway charge

Rabia
20th July 2017 1:07pm
What is meant by quantifiable economic event?

Rahul Goyal
21st July 2017 9:26pm
If trading expense and office expense are given on debit side of trial balance. Then what will be the effect in final a/c

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