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
- Steps in the Process of Finalization of Accounts
- Profit and Loss Account
- Liabilities on the Balance Sheet
- Assets on Balance Sheet
- Manufacturing Account
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.
Features of Trading Account
- It is the first stage in the preparation of financial accounting statement of a trading concern.
- It records only the net sales and direct cost of goods sold.
- The balance of this account discloses the gross profit and gross loss.
- 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
- Direct expenses
- Gross profit
In the case of trading concern, the opening stock means the finished goods only. We take the amount of opening stock from Trial Balance.
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.
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.
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
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.
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.
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…..
|Finished goods||Less: Sales return|
|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)|
Question on the Preparation of Trading Account
Following are the ledger balances of M/s. Praveen Kumar as on 31st March 2018.
|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|
(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.
In the books of M/s. Praveen Kumar
For the year ended 31st March 2018
|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|
|To Carriage Inwards||1,00,000|
|To Gas & Fuel||60,000|
|To Profit & Loss A/c (Gross Profit transferred)||10,00,000|
(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.