Financial Accounting

What is the Importance of Trading Account in Final Accounts

We all know that accounting is directed toward keeping systematic records of business transactions. These records are prepared with a view to ascertaining the results of financial activities by the business enterprise. This result may be either net profit or a net loss.

Net profit or net loss is ascertained preparing Profit & Loss A/c. But before calculating net profit, we need to find out the gross profit.

Gross profit is computed by preparing a trading account. Trading account is the summary of principle goods dealt with by the enterprise. Generally it the summary about sale and purchase transactions along with opening and closing stocks of the goods.

Format of trading A/c

Trading A/c for the year ending

Dr.                                                                                                                                                                 Cr.

To Opening Stock                                       XXXX             By Sales                                                         XXXX

To Purchases                                                 XXXX           By Closing Stock                                          XXXX

To Direct Expenses                                   XXXX                   

To Gross Profit c/d to P&L A/c          XXXX                    By Gross Loss c/d to P&L A/c              XXXX

ITEMS OF TRADING A/C

In a trading firm like a wholesaler, the main business is of buying and selling the same goods. In addition to the amount of the opening stock, all direct expenses will also be debited. For example, freight paid on purchases, octroi, cartage, etc. will all be debited to the Trading Account.

(1) Opening Stock: This item is usually put as the first item on the debit side of the Trading Account. However, in the first year of a business, there will be no opening stock.

(2) Purchases & Purchase Returns: The purchases account always have the debit balance,

showing the gross amount of purchases made. The purchase returns account will have a credit balance showing the return of materials to the suppliers. On the debit side of the trading account, the online amount is shown as indicated (with assumed figures):

To Purchases                        3,00,000

Less: Purchase Returns         (10,000)

Net Purchases                       2,90,000

It may happen sometimes that goods are received but the relevant invoice is not received from the supplier. On the date of the closing of the account, an entry should be passed to debit the purchases account and credit the supplier with the cost of goods.

(3) Carriage & Freight Inwards: Carriage or Freight Inwards should also be debited to the Trading Account, as it is incurred to bring the materials to the firm’s godown and make them available for use. However, if any freight or cartage is paid on any asset, like machinery, it should be added to the cost of the asset and not to be debited to the Trading Account.

(4) Wages: Wages paid to workers in the factory or godowns should be debited to the Trading Account. If any amount is outstanding, it must be brought into books so that full wages for the period concerned are charged to the Trading Account.

However, if wages are paid for the installation of an asset, it should be added to the cost of the asset. Misc. wages paid for part of the profit and loss account.

(5) Sales and Sales Returns: The sales account will always have a credit balance indicating the total sales made during the year. The sales return account will always have a debit balance, showing the total amount of goods returned by customers. The net of the two figures is entered on the credit side of the Trading Account.

(6) Closing Stock and its valuation: Usually there is no account to show the value of goods lying in the godown at the end of the year. However, in order to correctly ascertain the gross profit, the closing stock must be properly taken and valued. Its valuation is done by manually stock-taking at regular intervals or at least once in a year.

The entry to be passed is:

Closing Stock Account Dr.

To Trading Account

Alternatively, Closing stock can be adjusted with purchases:

Closing Stock Account Dr.

To Purchases Account

The end product of this entry is to reduce the debit in the Purchases Account. Then, it will appear in the trial balance. In this case, closing Stock Account is then not entered in the Trading Account and will be shown only in the Balance sheet.

To ascertain the value of the closing stock, it is necessary to make a complete inventory or list of all the items in the godown together with quantities. Damaged or obsolete items are separately listed.

To the list of finished goods, one should also add the goods lying with agents sent to them on the consignment basis and also the goods sent on approval to customers. The valuation principle is cost or net realizable value whichever is lower.

  1. Goods and Services Tax: Goods and Services Tax is an item of indirect tax. It is collected by the seller from the customers and deposited in Government’s Account as per the requirements of the Goods and Service Tax Act. Goods and Service Tax is to be deducted from gross sales figures and tax liability (net of payments) is shown as a current liability in the balance sheet.

Illustration 1

From the following information, prepare a Trading Account of M/s. RAJ Traders for the year

Ended 31st December, 2012:

($)

Opening Stock                                                  1, 00,000

Purchases                                                           6, 72,000

Carriage Inwards                                            30,000

Wages                                                                  50,000

Sales                                                                      11, 00,000

Returns inward                                                1, 00,000

Returns outward                                             72,000

Closing stock                                                     2, 00,000

Solution

                                                                In the books of M/s RAJ Traders

Trading A/c for the year ending 31st December 2012

Dr.                                                                                                                                                Cr.

To Opening Stock                                             100000                                By Sales                               1100000            

To Purchases                     672000                                                                Less: Returns                     100000           1000000

                Less: Returns      72000                 600000                                By Closing Stock                                            200000

To Carriage                                                     30000

To Wages                                                        50000                               

To Gross Profit c/d to P&L A/c                    420000                                                                                                                                                                                                                                                                         1200000                                                                                   1200000

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