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Trading Account:
Learning Objectives:

1. Define and explain a trading account.

2. What are the benefits of preparing a trading account?

Definition and Explanation:

The account which is prepared to determine the gross profit or gross loss of a business concern
is called trading account.

It should be noted that the result of the business determined through trading account is not
true result. The true result is the net profit or the net loss which is determined through profit
and loss account. The trading accounting has the following features:

1. It is the first stage of final accounts of a trading concern. Financial Accounting Topics

2. It is prepared on the last day of an accounting period. Introduction to Accounting

3. Only direct revenue and direct expenses are considered in it.
4. Direct expenses are recorded on its debit side and direct revenue on its credit side.
5. All items of direct expenses and direct revenue concerning current year are taken into
account but no item relating to past or next year is considered in it.
6. If its credit side exceeds it represents gross profit and if debit side exceeds it shows gross
loss.
Purpose of Preparing Trading Account:
The profit or loss determined by a trading account is the gross result of the business but not
the net result. If so, then a question arises - what is the use of preparing a trading account?
This account is necessary because of the following advantages.
1. Gross profit of a business is very important data, since all business expenses are met out
of it. So the amount of gross profit should be adequate to meet the indirect expenses of a
business concern.
2. The amount of net sales can be determined through this account. Gross sales can be
ascertained from sales account in the ledger, but net sales cannot be so obtained. The
true sales of a business is net sales - not gross sales. Net sales are determined by
deducting sales returns from gross sales in trading account.
3. The success or failure of a business can be ascertained by comparing net sales of the
current year with that of the last year. It should be noted that an increase in the amount
of net sales of the current year over the last year may not be regarded as a sign of
success, since sales may increase because of rise in price level.
4. Percentage of gross profit on net sales (gross profit ratio) can be easily determined from
trading account. This percentage is very important yardstick for measuring the success or
failure of a business. Compared to last year, if the rate increases, it indicates success; on
the other hand if the rate decreases, it is an indication of failure.
5. Percentage of different items of buying expenses (direct expenses) on gross profit can be
easily determined and by comparing the percentage of the current year with that of the
previous year the variations can be ascertained. An analysis of variances will disclose
their cause which will help in controlling the amount of expenses.
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Transactions and Accounting Equation
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Analysis of Business Transactions
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Journal, Ledger and Trial Balance
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Accounting for Bills of Exchange
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Special Journals
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Cash Book
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Bank Reconciliation Statement
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Final Accounts
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Work Sheet
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Capital and Revenue Items
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Valuation of Inventories
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Accounts of Non-profit Making Organizations
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Statement of Cash Flows
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Accounting Ratios Analysis
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Depreciation, Provisions and Reserves
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Accounting Dictionary
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Financial Calculators

6. Inventory or stock turnover ratio can be determined from trading account. The success or
failure of a business can be measured by this rate. Higher rate indicates a favorable sign
i.e. goods are sold soon after their purchase. On the other hand, low rate signifies
deterioration, i.e. goods are sold long after their purchase.

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Method of Preparation of Trading Account:

Managerial Accounting Topics
Trial balance is a list of all ledger accounts balances, so all the necessary information for
preparation of a trading account is available from the trial balance. As gross profit or gross loss Financial Statements
of a particular period is determined through trading account. So it's heading will be as follows:
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XYZ co. Cost Volume Profit Relationship
Trading Account for the year ended 31.12.2005 ----------------------------------------------------------------------------
(if accounting period ends on 31.12.2005) Variable Costing System
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From the trial balance, the balance of opening stock account, purchases account, returns
inwards account and of all direct expenses are transferred on the debit side of the trading Materials and Inventory Cost Control
account, and the balance of the sales account, returns outwards account, and closing stock ----------------------------------------------------------------------------
account are transferred on the credit side of the trading account. If the credit side of the Activity Based Costing System
trading account exceeds the debit side, the result is "gross profit", and if debit side exceeds the ----------------------------------------------------------------------------
credit side, the result is "gross loss". The format of a trading account is shown below: Standard Costing and Variance Analysis
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Name of Business
Trading Account for the year ended ..... Balanced Scorecard
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Capital Investment Analysis/Capital Budgeting
$ $
Stock (Opening) Sales -----
Purchases ----- Less returns ----- -----
Less returns ----- -----
Stock (closing) -----
Carriage inward ----- Gross loss (Transferred to P&l A/C) -----
Wages -----
Insurance in transit -----
Custom duty -----
Clearing charges -----
Freight inward -----
Transportation inward -----
Excise duty on goods -----
Royalty -----
Dock charges -----
Coal, Coke, Gas, fuel -----
Motive power -----
Oil, water -----
Gross profit (Transferred to P&l A/C) -----

If credit side exceeds the debit side = Gross profit

If debit side exceeds the credit side = Gross loss

Example:
The following are some ledger balances taken out from the trial balance of XYZ company on
31st December 2005.

$ $
Stock on 1.12005 60,000 Returns outwards 16,000
Purchases 360,000 Returns inwards 30,000
Carriage inwards 24,000 Sales 500,000
Custom duty 12,000

The closing stock is valued at $10,000.

Required:

Prepare a trading account for the year ended 31st December 2005. Show the journal entries to
close the above account (closing entries).

Solution:

xyz co.
Trading Account for the year ended 31.12.2005

$ $
Stock 1.1.2005 60,000 Sales 500,000
Purchases 3,60,000 Less returns 30,000 470000
Less returns 16,000 3,44,000
Stock (closing) 100,000
Carriage inward 24,000
Custom duty 12000
Gross profit (transf. to P&L A/C) 130,000

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570,000 570,000

Closing Entries:

Date Description L/F Amount ($) Amount ($)

2005

Dec.31 Trading account 486,000

Stock (opening) account 60,000

Purchase account 360,000

Returns inwards account 30,000

Carriage inwards account 24,000

Custom duty 12,000

(Being transferred of above A/C to trading account)

Dec.31 Sales account 500,000

Returns outwards account 16,000

Trading account 516,000

(Being transferred of above A/C to trading account)

Dec.31 Stock (closing) account 100,000

Trading account 100,000

(Being closing stock taken into account)

Dec.31 Trading account 130,000

Profit and loss account 130,000

(Being gross profit transferred to P&L account)

» Definition and Explanation of Final Accounts

» Trial Balance - A Starting Point for Final Accounts
» Meanings and Sources of Revenue
» Direct and Indirect Expenses
» Matching Revenue and Expenses
» Trading Account
» Profit and Loss Account
» Difference between Trading Account and Profit and Loss Account
» Difference between Gross Profit and Net Profit
» Balance Sheet
» Difference between Trial Balance and Balance Sheet
» Example of Trading and Profit and Loss Account and Balance Sheet

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