Trading and Profit & Loss Account
Trading and 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 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 & 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 appear 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 purchases return. It is shown by way of deduction from purchases and the computed amount is known as Net purchases.
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.
These items are used in the production process and hence are part of expenses.
6. Packaging material and Packing charges:
The cost of packaging material used in the product is the direct expense as it refers to small containers which form part of the goods sold. However, packing refers to the big containers that are used for transporting the goods and are regarded as an indirect expense debited to the profit and loss account.
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, uniforms, and 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 overdrafts, renewal of bills of change, etc. is an expense and is debited to a 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 the 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, certain expenses are of small amounts clubbed together and are called miscellaneous expenses. In normal usage, these expenses are called Sundry expenses or Trade expenses.
Items on the credit side
I. Sales & Sales Returns:
The sales account in the 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.
II. 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, commission received, etc.
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 their 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 income, 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 & Loss Account of ABC
for the year ended March 31, 2018
(less Purchase Return) ———–
|(Fewer Sales Return) —————-
Packaging material and Packing charges
|Gross Profit c/d
|Gross Profit b/d
|Gross Loss c/d
|Gross Profit b/d
|Rent/Rates & Taxes
|Repair & Maintenance
|Net Profit ( Transferred to Capital A/c)
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 the profit and loss account or the second part ascertains the net profit.
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 buildings, and bad debts. Out of those items, wages are 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:
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 for 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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