Trading and Profit & loss Account

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Trading and Profit and Loss Account

Trading & Profit & Loss account are prepared to determine the profit earned or loss sustained by the business enterprise during the accounting period. It is basically a summary of the revenues and expenses of the business and calculates the net figure termed as profit or loss. Profit is revenue for fewer expenses. If expenses are more than revenues, the figure is termed as a loss.

Trading and Profit and Loss account summarise the performance for an accounting period. It is achieved by transferring the balances of revenues and expenses to the trading and profit and loss account from the trial balance. Trading and Profit and Loss account is also an account with Debit and Credit sides. It can be observed that debit balances (representing expenses) and losses are transferred to the debit side of the Trading and a Profit and Loss account and credit balance (representing revenues/gains) are transferred to its credit side.

Relevant Items in Trading and Profit and Loss Account

The different items appearing in the trading and profit and loss account are explained hereunder:

Items on the debit side
  1. Opening stock:- It is the stock of goods in hand at the beginning of the accounting year. This is the stock of goods that have been carried forward from the previous year and remains unchanged during the year and appears in the trial balance. In the trading account, it appears on the debit side because it forms part of the cost of goods sold for the current accounting year. 
  2. Purchase & Purchase Return:-Goods, which have been bought for resale appears as purchases on the debit side of the trading account. They include both cash as well as credit purchases. Goods that are returned to suppliers are termed as purchases return. It is shown by way of deduction from purchases and the computed amount is known as Net purchases.
  3. Wages:- Wages refer to remuneration paid to workers who are directly engaged in the factory for loading, unloading and production of goods and are debited to the trading account.
  4. Carriage/Freight inwards:-These expenses are the items of transport expenses, which are incurred on bringing materials/goods purchased to the place of business. These items are paid in respect of purchases made during the year and are debited to the trading account.
  5. Fuel/Water/Power/Gas:- These items are used in the production process and hence are part of expenses.
  6. Packaging material and Packing charges:- Cost of packaging material used in the product are direct expenses as it refers to small containers which form part of goods sold. However, packing refers to the big containers that are used for transporting the goods and is regarded as an indirect expense debited to the profit and loss account.
  7. Salaries:- These include salaries paid to the administration, godown and warehouse staff for the services rendered by them for running the business. If salaries are paid in kind by providing certain facilities (called perks) to the employees such as rent-free accommodation, meals, uniform, medical facilities should also be regarded as salaries and debited to the profit and loss account.
  8. Rent Paid:- These include office and godown rent, municipal rates and taxes, factory rent, rates and taxes. The amount of rent paid is shown on the debit side of the profit and loss account.
  9. Interest Paid:- Interest paid on loans, bank overdraft, renewal of bills of change, etc. is an expense and is debited to profit and loss account.
  10. Commission Paid:- Commission paid or payable on business transactions undertaken through the agents is an item of expense and is debited to profit and loss account.
  11. Repairs & Maintainance:- Repairs and small renewals/ replacements relating to plant and
    machinery, furniture, fixtures, fittings, etc. for keeping them in working condition are included under this head. Such expenditure is debited to the profit and loss account.
  12. Miscellaneous expenses:- Though expenses are classified and booked under different heads, but certain expenses being of small amount clubbed together and are called miscellaneous expenses. In normal usage, these expenses are called Sundry expenses or Trade expenses.
Items on the credit side
  1. Sales & Sales Returns:- Sales account in trial balance shows gross total sales(cash as well as credit) made during the year. It is shown on the credit side of the trading account. Goods returned by customers are called return inwards and are shown as a deduction from total sales and the computed amount is known as net sales.
  2. Other incomes:- Besides salaries and other gains and incomes are also recorded in the profit and loss account. Examples of such incomes are rent received, dividend received, interest received, discount received, the commission received, etc.

Closing Entries

The preparation of trading and profit and loss account requires that the balances of accounts of all concerned items are transferred to it for its compilation.

  • Opening Stock account, Purchases account, Wages account, Carriage inwards account and direct expenses account are closed by transferring to the debit side of the trading and profit and loss account. This is done by recording the following entry : 

Trading A/c                                Dr.
To Opening stock A/c
To Purchases A/c
To Wages A/c
To Carriage inwards A/c
To All other direct expenses A/c

  • The Purchases return or return outwards are closed by transferring its balance to the purchases account. The following entry is recorded for this purpose :

Purchases return A/c                 Dr.
To Purchases A/c

  • Similarly, the sales returns or returns inwards account is closed by transferring its balance to the sales account as :

Sales A/c                                 Dr.
To Sales return A/c

  • The sales account is closed by transferring its balance to the credit side of the trading and profit and loss account by recording the following entry:

Sales A/c                                 Dr.
To Trading A/c

Items of expenses, losses, etc. are closed by recording the following entries:
Profit and Loss A/c                         Dr.
       To Expenses (individually) A/c
       To Losses (individually) A/c

Items of incomes, gains, etc. are closed by recording the following entry:
Incomes (individually) A/c               Dr.
Gains (individually) A/c                   Dr.
       To Profit and Loss A/c

 

Trading and Profit and Loss Account of ABC
for the year ended March 31, 2018

Dr.                                                                                                                                  Cr.

Expenses/Losses Amount Rs. Revenues/Gains Amount Rs.
Opening Stock ————— Sales ————–
 

Purchases

(less Purchase Return) ———–

————— (Less Sales Return) —————-  

 

Wages —————    
 

Carriage/Freight inwards

 

—————    
Fuel/Water/Power/Gas —————    
 

Packaging material and Packing charges

 

—————    
Gross Profit c/d      
Gross Profit b/d      
xxxxxxx    xxxxxxx 
  Gross Loss c/d ———
  Gross Profit b/d ———
Rent/Rates & Taxes ————— Interest Received ——–
Salaries —————   —-—–
Repair & Maintenance —————    
Bad debts —————    
Net Profit ( Transferred to Capital A/c) ————– Net Loss ———
xxxxxxxxx   xxxxxxxxx

Concept of Gross Profit and Net Profit

The trading and profit and loss can be seen as a combination of two accounts, viz. Trading account and Profit and Loss account. The trading account or the first part ascertains the gross profit and profit and loss account or the second part ascertains net profit.

Trading Account:- The trading account ascertains the result from the essential operating activities of the business. the essential operational activity involves the manufacturing, purchasing and selling of products. it’s prepared to determine whether the selling of products and/or the rendering of services to customers have proved profitable for the business or not. Purchases are one of the foremost constituents of expenses within the business. Besides purchases, the remaining expenses are divided into two categories, viz. direct expenses and indirect expenses.

Direct expenses mean all expenses directly connected with the manufacture, purchase of products and bringing them to the aim of sale. Direct expenses include carriage inwards, freight inwards, wages, factory lighting, coal, water and fuel, royalty on production, etc. In our example-1, besides purchases, four more items of expenses are listed. These are wages, salaries, rent of building and bad debts. Out of those items, wages is treated as an immediate expense while the opposite three are treated as indirect expenses.

Similarly, sales constitute the main item of revenue for the business. The excess of sales over purchases and direct expenses is called gross profit. If the amount of purchases including direct expenses is more than the sales revenue, the resultant figure is a gross loss. The computation of gross profit can be shown in the form of an equation as :

Gross Profit = Sales – (Purchases + Direct Expenses)

The gross profit or the gross loss is transferred to the profit and loss account.

The indirect expenses are transferred to the debit side of the second part, viz. profit and loss account. All revenue/gains other than sales are transferred to the credit side of the profit and loss account. If the total of the credit side of the profit and loss account is more than the total of the debit side, the difference is the net profit for the period of which it is being prepared. On the other hand, if the total of the debit side is more than the total of the credit side, the difference is the net loss incurred by the business firm. In an equation form, it is shown as follows :

Net Profit = Gross Profit + Other Incomes – Indirect Expenses

Net profit or net loss so computed is transferred to the capital account in the balance sheet by way of the following entry :

(i) For transfer of net profit
Profit and Loss A/c                           Dr.
      To Capital A/c

(ii) For transfer of net loss
Capital A/c                                      Dr.
      To Profit and Loss A/c

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