Trading account shows the result of buying and selling of goods, It is prepared to determine the gross profit or the gross loss of a trader. It is prepared at the stage of final accounts preparation.
The following items usually appear on the debit and credit side of Trading Account.
On the debit side:
- Stock in hand at the beginning. (Opening Stock)
- Net Purchases made during the year (Total Purchases less Purchases Returns).
- All Direct Expenses
On the credit side:
- Net Sales (Total Sales less Sales Returns)
- The value of the closing stock of goods.
Gross profit or gross loss
In accounting parlance, Gross profit or gross loss is the difference between sale proceeds of a certain period and the cost of goods actually sold in the same period. Gross profit is made when the sales proceeds exceed the cost of goods sold. Gross profit means overall profit, overall profit means operating expenses such as administrative and selling expenses are not deducted from it. If sales proceeds are less than the cost of the goods sold, gross loss is incurred. The balance of the trading account which represents either gross profit or gross loss is transferred to Profit and Loss Account.
Features of Trading Account
Trading Account has the following features:
- It is a Nominal Account.
- It is prepared on the last day of an accounting year.
- It is the first stage of the Final Account of a trader and the second stage of the Final Accounts of a manufacturer.
- Only revenue transactions are included in it. No capital item is taken into account.
- It has no opening balance. In the case of a manufacturing concern, it starts with the balance of Manufacturing Account.
- It is debited with the cost of goods sold and all the expenses connected with the purchase of goods and credited with sale proceeds of goods. Expenses concerning sale of goods (operating expenses) are not recorded here — these are included in Profit or Loss Account.
- All expenses relating to the current year — whether paid in cash or not — are taken into account. But expenses relating to past or next year are not included in it.
- All revenues relating to the current year — whether received in cash or not — are taken into account. But revenues relating to past or next year are not included in it.
- Its balance indicates gross profit or gross loss. Credit balance represents gross profit, while debit balance represents gross loss.
- Gross profit or gross loss is transferred to Profit or Loss Account.
Advantages of Trading Account
As profit or loss determined through Trading Account is not the net result of the business. so, the question naturally arises — what is then the use of preparing Trading Account? The answer is Trading Account is necessary since it gives the following advantages:
- Trading Account discloses gross profit from which all expenses are deducted to find out the true profit of the business i.e. net profit.
- Gross profit of a business is a very important data since all business expenses are met out of gross profit. So, the amount of gross profit should be adequate to meet all the expenses.
- The amount of net sales can be had at a glance through it. Gross sales can be ascertained from Sales Account in Ledger, but net sales cannot be so obtained. The true sale of a business is net sales — not gross sales. Net sales are determined by deducting sales Returns from gross sales. Similarly, the amount of net purchases can also be had at a glance through the Trading Account.
- The progress or failure of a business can be ascertained by comparing net sales of the current year with that of last year. It is to be noted here that an increase in the amount of net sales of current year over last year may not always be regarded as a sign of success, since sales may increase because of rise in price level. Conversely, a fall in the amount of net sales of current year over last year may decrease because of fall in price level.
Format/Specimen of Trading Account
Now, students should note that by passing the above closing entries and following the posting procedure, how these items are transferred to Trading Account.
How the related items travel to Trading Account?
While preparing Trading Account, an important point must be kept in mind that closing entries are made at the end of each accounting period to transfer the direct expenses and direct revenues accounts to Trading Account. These closing entries are made in the General Journal (Journal Proper). After making closing entries, the balances of these accounts disappear from the ledger, since they are closed and transferred to Trading Account.
Closing entries to transfer different items in Trading Account
For the items of debit side:
Sales Returns Account has debit balance and it is closed to Trading Account just like other accounts following the principle of Double Entry System. But in practice, it is not recorded on the debit side of Trading Account, rather it is deducted from Sales Account on the credit side of Trading Account.
For the items of credit side:
Purchases Returns Account has a credit balance and it is closed to Trading Account just like other accounts following the principle of Double Entry System. But in practice it is not recorded on the credit side of Trading Account, rather it is deducted from Purchases Account on the debit side of Trading Account.
For gross profit:
For gross loss:
From the following trial balance of ZB Sons., Prepare trading account from the year ended 31 December 2019.
The Closing Stock was valued at $1,60,000.