Trading account is prepared to ascertain the Gross Profit and Loss of a firm, where Gross Profit is the excess of net revenue over cost of goods sold (the credit side of the trading account exceeds the debit side). Similarly, Gross Loss is the excess of cost of goods sold over net revenue (the debit side of the trading account exceeds the credit side).
Gross Profit = Net Sales Revenue – Cost of Goods Sold Gross Loss = – (Net Sales Revenue – Cost of Goods Sold)
Net Sales Revenue = Cash Sales + Credit Sales – Sales Returns
Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses – Closing Stock
Net Purchase = Cash Purchases + Credit Purchases – Purchases Returns.
Trading Account is generally prepared in ‘T’ form. In this case, opening stock, purchases and direct expenses are shown on the debit side and sales and closing stock on the credit side of the trading account. The format of the Trading Account is explained along with the format of Profit and Loss Account.
The Opening Stock of goods is the stock of goods in hand at the beginning of an accounting year. This may include stock of raw material, work-in-progress and fininshed goods. This appears in the debit column of the trial balance. In the Trading Account this is the first entry on the debit side. The valuation is usually done at cost or market price which ever is lower. The Stock of goods in hand at the end of accounting year is called Closing Stock. Similarly, closing stock may include stock of raw material, work-in-progress and finished goods. The closing stock is shown on the credit side of the Trading Account. Closing stock is usually not given in the trial balance but is given by way of additional information.
These include goods purchased only for production and selling purposes. Goods used as assets and not- for- sale are not included in this head. Net purchase is the difference between purchases and the purchase return, where purchase is the sum of cash and credit purchase. Note that sometimes, purchased return is known as Return Outward
Direct expenses include all those expenses incurred in bringing the goods to the place of business or trade or in-production process until the goods are placed in a saleable position. The following expenses may be considered as direct expenses:
- Wages paid to workers engaged in production are debited to the trading account provided the manufacturing account is not prepared separately. 2. Carriage/freight inwards are transportation expenses incurred to bring the goods or raw material to the place of the business or to the firm’s godown/factory. Such expenses, whether paid or outstanding, are debited to trading account.
- Octroi is paid when goods enter municipal limits. Octroi paid on goods purchased is a direct expense and is debited to trading account.
- Custom duty paid on importing goods for selling purposes is debited to trading account. If the duty is paid on sales export, it amounts to selling expenses and is shown in the profit and loss account.
- Factory rent, insurance, lighting & power and heating are the expenses incurred to convert raw material into finished goods. Such expenses are debited to trading account.