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Home > Fundamentals of Accounting > Final Accounts > Preparation of Trading Account
Final Accounts

Preparation of Trading Account

At the end of the financial year or at the end of the financial accounting period, an entity prepares the financial accounting statements to know the profit and loss and also the financial position of the business. These statements help users of financial accounting, information in decision making. In this article, we will see the steps of preparation of trading account.

Browse more Topics under Final Accounts

Financial Accounting Statements include – 

  • A balance sheet
  • A trading and profit and loss account
  • Schedules and notes.

Preparation of Trading Account

Trading account is the first step in the process of preparing final accounts. It helps in finding out the gross profit or gross loss during an accounting year, which is an important indicator of business efficiency.

It is normally prepared by a merchandising concern which purchases and sells the goods during a particular period.

The trading account shows the gross profit or gross loss during the accounting period. Trading account is based on matching the selling price of goods and services with the cost of goods sold and services rendered.

Preparation of trading account

source: keydifferences.com

Features of Trading Account

  1. It is the first stage in the preparation of financial accounting statement of a trading concern.
  2. It records only the net sales and direct cost of goods sold.
  3. The balance of this account discloses the gross profit and gross loss.
  4. We transfer the balance of the trading account to the profit and loss account.

Read more about Recording Transaction here in detail

Contents of a Trading Account

Trading Account Statement include

  • Opening Stock
  • Purchases
  • Direct expenses
  • Gross profit

Opening Stock

In the case of trading concern, the opening stock means the finished goods only. We take the amount of opening stock from Trial Balance.

Purchases

The amount of purchases during the year includes cash as well as credit purchases. The deductions from purchases are purchase return, drawings of goods by the proprietor, distribution of goods as free samples, etc.

Direct expenses

It means all those expenses which are incurred from the time of purchases to making the goods in suitable condition. This expense includes freight inward, octroi, wages etc.

Gross profit

If the credit side of Trading A/c is greater than the debit side of Trading A/c gross profit will arise.

The following are the items appearing in the credit side of Trading Account

  • Sales Revenue
  •  Closing Stock
  •  Gross Loss

Sales Revenue

The sales revenue i.e. the income earned from the main business activity or activities. When goods or services are sold to customers then the income is earned.

If there is any return, it should be deducted from the sales value. As per the accrual concept, income should be recognized as soon as it is accrued and not necessarily only when the cash is paid for.

The Accounting standard 7 (in case of contracting business) and Accounting standard 9 (in other cases) define the guidelines for revenue recognition.

The essence of the provisions of both standards is that revenue should be recognized only when significant risks and rewards (vaguely referred to as ownership in goods) are transferred to the customer.

Example, if an invoice is made for the sale of goods and the term of sale is door delivery, and then recognition of sale can be done only on getting proof of delivery of goods at the door of the customer.

And if such proof is pending at the end of the accounting period, then we can not treat this transaction as sales but will have to treat it as unearned income.

 Closing Stock

In the case of trading business, there will be closing stocks of finished goods only. According to the convention of conservatism, the stock is valued at cost or net realizable value whichever is lower.

Gross Loss

When the debit side of Trading A/c is greater than the credit side of Trading A/c, the gross loss will appear.

 Format of Trading Account

 A general format of the trading account is

Trading Account for the year ended…..

Particulars Amount Particulars Amount
Opening Stock:   Sales  
Finished goods   Less: Sales return  
Purchases   Closing stock  
Less: Purchase returns   Finished goods  
Direct expenses   Abnormal loss of stock  
Gross Profit (transferred to P&L A/c)   Gross Loss (transferred to P&L A/c)  
Total   Total  

 Question on the Preparation of Trading Account

 Following are the ledger balances of M/s. Praveen Kumar as on 31st March 2018.

Particulars Amount Particulars Amount
Stock (1.4.2017) 1,00,000 Sales 30,00,000
Purchase 16,00,000 Return Inward 1,60,000
Carriage Inwards 1,00,000 Return Outward 1,00,000
Wages 3,00,000 Royalty on Production 60,000
Freight 80,000 Gas and Fuel 20,000

Additional Information:

(1) Stock on 31.3.2018: (i) Market Price ₹ 2,40,000; (ii) Cost Price ₹  2,00,000.

(2) Stock valued ₹  1,00,000 were destroyed by fire and insurance company admitted the claim to the extent of ₹  60,000.

(3) Goods purchased for ₹  60,000 on 29th March 2018, but still lying in-transit, not at all recorded in the books.

(4) Drawings of goods by the proprietor for his own use for ₹  30,000.

(5) Outstanding wages amounted to ₹  40,000.

(6) Freight was paid in advance for ₹  10,000.

Ans:

In the books of M/s. Praveen Kumar

Trading Account

For the year ended 31st March 2018

Particulars Amount Particulars Amount
To Opening Stock 1,00,000 By Sales 30,00,000
To Purchase 16,00,000 Less: Return Inward 1,60,000 28,40,000
Less: Return Outward 1,00,000 By Closing Stock 2,00,000
15,00,000 Add: Stock Destroyed 1,00,000
Less: Goods were taken by Proprietor 30,000
14,70,000 Add: Goods-in-Transit 60,000 3,60,000
Add: Goods-in-transit 60,000 15,30,000
To Wages 3,00,000
Add: Outstanding 40,000 3,40,000
To Carriage Inwards 1,00,000
To Freight 80,000
Less: Prepaid 10,000 70,000
To Gas & Fuel 60,000
To Profit & Loss A/c (Gross Profit transferred) 10,00,000
32,00,000 32,00,000

 

Note:

(a) The stock should be valued as per cost price or market price whichever is lower.

(b) The claim which was admitted by the insurance company and the loss of stock, will not appear in Trading Account.

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