Trading account is the first step of final account which is prepare to ascertain gross profit or gross loss of a business. It helps to show the results of buying and selling of goods during an accounting period. The amounts of purchase of goods which are incurred in bringing the commodities to a salable state are recorded in the trading account.
Objective of Trading Account
The main objectives of preparing a trading account are as below:
To know gross profit or gross loss.
To provide safety against possibility losses.
To provide information about the direct expenses.
To compare of closing stock with the stock of last years.
Importance of Trading Account
The main importances of trading account are as follows:
It helps to measure profitability position of the business by showing the relationship between gross profit and sales.
It shows the ratios between costs of goods sold and gross profit.
It provides the information regarding the efficiency of trading activities.
It makes easier to compare among sales, cost of goods sold and gross profit.
It helps to provide information regarding closing stock.
Preparation of Trading Account
All the direct expenses are shown on debit side and all sales and closing stock are shown on credit side of trading account. The format of trading account is as under:
Trading Account of…………………….. For the year ending……………..
To Opening stock
By Sales XXX Less: Return inwards XXX
To Purchase XXX Less: Return outwards XXX
By Closing stock
To Custom duty/Excise duty/Import duty
By Gross loss c/d
To Carriage/Carriage on purchase
To Freight/Freight on purchase
To Wages/Productive wages
To Duty and clearing charges
To Municipal charges
To Commission on purchase
To Royalty on production
To Manufacturing/Factory expenses
To Store consumed
To Motive power
To Coal, coke, gas and oil
To water supply
To factory expenses
To Gross profit c/d
The items which are written on the debit side of trading account have been given below
Opening stock: It is available in the trial balance. The amount of closing stock consists of raw materials, work in progress and finished goods.
Purchase: It is available in the trial balance. It includes both cash and credit purchase.
Purchase returns: It is available on the credit side of trial balance. It is shown by deducting from purchases in the trading account or it is kept on the credit side of trading account.
Direct expenses: The expenses which are directly attributable to the purchase of goods are known as direct expenses. Some example of direct expenses are as follows:
Freight or Freight inward or Freight on a purchase: Freight paid related with acquiring goods are debited to trading account.
Carriage or Carriage inward or Carriage on a purchase: Carriage inwards are the carriage paid to bring the goods to the godown of a factory. It is debited to trading account.
Wages or Salary or Labor or Direct wages or Direct labor: Wages or salary incurred in a business is direct which are shown in debit side of trading account. Other wages are indirect wages which are debited to profit and loss account. If it is not mentioned whether wages are direct or indirect then it should be assumed as direct and should keep in debit side of trading account.
Fuel and motive power expenses: They are considered as direct expenses as they are directly related to the production. It is debited to trading account.
Octroi:Octroi duty is paid to a municipal committee or municipal corporation when the goods are brought into the municipal limits. It is considered as direct expenses and is debited in a trading account.
Manufacturing expenses: Manufacturing expenses are the expenses incurred in a factory for manufacturing the goods such as factory rent, factory insurance, factory lighting etc. It is debited in a trading account.
Royalty: It is considered as direct expenses and it is debited in a trading account.
Commission on a purchase: It is the part of a cost of goods purchased so it is direct expenses. It is debited to trading account.
Items which are written on the credit side of trading account are given below
Sales: Sales include both cash and credit sales of goods. It is recorded in the credit side of trading account.
Sales Return: Sales return are the goods which are returned by the customer for some reasons. It is deducted from the total sales and the net amount of sales is to be shown in the credit side of trading account.
Closing stock: The closing stock is the value of goods which remain unsold at the end of the accounting period. Closing stock consists of raw materials work in progress and finished goods. If appears in trial balance then it is considered as assets and recorded in assets side of balance sheet.
Note: The closing stock given in adjustment or outside the trial balance is recorded in credit side of trading account and assets side of balance sheet.
Balance of Trading Account
The trading account is balanced after recording the above items on the respective side of the trading account. The balancing figure may appear in the form of gross profit or gross loss. If a debit side of a trading account is less than credit side, the difference represents to gross profit. Similarly, if the credit side of a trading account is less than debit side, the difference represent to gross loss. The gross profit and gross loss are transferred to credit and debit side of profit and loss account respectively.
Consider the following information of a Trading concern for the year ending on 31stChaitra 2054:
Opening stock Rs. 75000
Sales Rs. 500000
Wages Rs. 3000
Return inward Rs. 5000
Return outward Rs. 5000
Closing stock Rs. 40000
Trading Account………………………………… For the year ending 31stChaitra 2054
To Opening stock
By Sales 500000 Less: Return inwards 5000
To purchase 30000 Less: Return outwards 5000
By Closing stock
To Gross profit c/d
Closing Entries for Trading Account
At the end of the year, the balances of nominal accounts are to be closed down by transferring either into trading account or Profit and Loss account. Closing entries are the entries which are made to record the expenses and incomes related to the trading account.
Accounts to be closed:
For purchase return account
For opening stock, purchase, purchase expenses and other direct expenses
For sales return account
For sales and closing stock
For gross profit (if any)
For gross loss (if any)
Required: Closing entries
Purchase return a/c………………………Dr To Purchase a/c (Being purchase return account closed transferring into purchase account)
Trading a/c…………………………….Dr To Opening stock a/c To Purchase a/c To Purchase expenses a/c To direct expenses a/c (Being purchase, purchases expenses and direct or trading expenses are closed transferring into trading account)
XXX XXX XXX XXX
Sales a/c………………………….Dr To Sales return a/c (Being sales account is closed transferring into sales account)
Sales a/c………………………Dr Closing stock a/c……………..Dr To Trading a/c (Being sales and closing stock are closed transferring into trading account)
Trading a/c……………………………Dr To Profit and Loss a/c (Being gross profit transferred to P/L account)
Profit and Loss a/c…………………..Dr To Trading a/c (Being gross loss transferred to P/L account)
Sharma, Narendra et.al., Principles of Accounting-XI, Bundipuran Prakashan, Kathmandu