In order to arrive at the balance sheet of a business, one needs to prepare the trading account and profit and loss account first. This account is prepared to arrive at the figure of revenue earned or loss incurred during a period. Let us understand the trading account and profit and loss account in detail.
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What is a Trading Account?
A trading account helps in determining the gross profit or gross loss of a business concern, made strictly out of trading activities. Trading involves buying and selling activities. In the trading account, the cost of goods sold is subtracted from net sales for the period to calculate gross profit. Only direct revenue and direct expenses are considered in it. Trading account is prepared mainly to know the profitability of the goods bought by the businessman.
Learn about Balance Sheet and Opening Entry here in detail.
The difference between selling price and cost of goods sold is the earning for the businessman, which is also known as gross profit. Whereas, net profit means all revenues minus all expenses including the cost of goods sold, the selling, general and administrative expenses, and the non-operating expenses. Thus in order to calculate the gross earning, it is necessary to know the cost of goods sold and sales figures. Also,
Gross Profit = Sales – COGS (Sales + Closing Stock) – (Stock in the beginning + Purchases + Direct Expenses)
Items included on the debit side are opening stock, purchases, and direct expenses and on the credit side are sales and closing stock. The resultant figure is either gross profit or gross loss.
Browse more Topics under Financial Statements
- An Introduction to Financial Statements
- Distinction between Capital Revenue and Capital Expenditure
- Operating Profit
- Balance Sheet and Opening Entry
- Stakeholders and their Information Requirement
- Depreciation, Bad Debts and Provision for Bad and Doubtful Debts
- Need for Adjustment, Closing Stock and Outstanding Expenses
- Prepaid Expenses, Accrued Income and Income Received in Advanced
- Provision for Discount on Debtors, Managers Commission and Interest on Capital
- Manufacturing Account
Closing entries for Gross Profit/Loss
In case of gross profit:
Trading A/c -Dr.
To Profit and Loss A/c
And, in case of gross loss:
Profit and Loss A/c -Dr.
To Trading A/c
What is the Profit and Loss Account?
The profit and loss account is opened by recording the gross profit on the credit side or gross loss on the debit side.
For earning the 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 a gross loss and thus, the resultant figure will be net profit or a net loss.
Expenses included in the profit and loss account are Selling and distribution expenses, Freight & carriage on sales, Sales tax, Administrative Expenses, Financial Expenses, Maintenance, depreciation and Provisions and more. On the credit side, Discount received, Commission received, Profit on sale of assets and more appear.
What is the difference between Capital Revenue and Capital Expenditure?
Closing entries for Net Profit/Loss
In case of a net profit:
Profit and Loss A/c -Dr.
To Capital A/c
And, in the case of net loss:
Capital A/c -Dr.
To Profit and Loss A/c
Solved Question for You
Question: The following trial balance has been taken out from the books of XYZ as on 31st December 2009.
| Particulars | Dr. | Cr. |
| Plant and Machinery | 100,000 | |
| Opening stock | 60,000 | |
| Purchases | 160,000 | |
| Building | 170,000 | |
| Carriage inward | 3,400 | |
| Carriage outward | 5,000 | |
| Wages | 32,000 | |
| Sundry debtors | 100,000 | |
| Salaries | 24,000 | |
| Furniture | 36,000 | |
| Trade expense | 12,000 | |
| Discount on sales | 1,900 | |
| Advertisement | 5,000 | |
| Bad debts | 1,800 | |
| Drawings | 10,000 | |
| Bills receivable | 50,000 | |
| Insurance | 4,400 | |
| Bank balances | 20,000 | |
| Sales | 480,000 | |
| Interest received | 2,000 | |
| Sundry creditors | 40,000 | |
| Bank loan | 100,000 | |
| Discount on purchases | 2,000 | |
| Capital | 171,500 | |
| 795,500 | 795,500 | |
Closing stock is valued at INR 90,000. Prepare the trading and profit and loss account of the business for the year ended 31.12.2009 and a balance sheet as at that date.
Solution:
XYZ
Trading and Profit and Loss Account
For the year ended 31st, December 2009
| Particulars | Amt | Amt | Particulars | Amt | Amt | |
| Opening stock | 60,000 | Sales | 480,000 | |||
| Purchases | 160,000 | Less discount | 1,900 | 478,100 | ||
| Less discount | 2,000 | 158,000 | ||||
| Closing stock | 90,000 | |||||
| Carriage inward | 3,400 | |||||
| Wages | 32,000 | |||||
| Gross profit (transferred to P&L) | 314,700 | |||||
| 568,100 | 568,000 | |||||
| Carriage outward | 5,000 | Gross profit (transferred to P&L) | 314,700 | |||
| Salaries | 24,000 | Interest received | 2,000 | |||
| Trade expenses | 12,000 | |||||
| Advertisement | 5,000 | |||||
| Bad debts | 1,800 | |||||
| Insurance | 4,400 | |||||
| Net profit (transferred to capital) | 264,500 | |||||
| 316,700 | 316,700 |
