Trading, Profit and Loss Account and Balance Sheet

Trading, Profit and Loss Account and Balance Sheet

Introduction

To determine how much a business earns, spends, and ultimately, how profitable it is; it needs to track its financial performance. Hence preparing a trading and profit and loss account statements help to find that. A trading and profit and loss account comes first before moving on to the balance sheet.

Trading and profit and loss accounts are useful in identifying the gross profit and net profits that a business earns. These two determines the revenue earned or the losses incurred during the accounting period.

The trading and profit and loss account are two different accounts that are formed within the general ledger. The two parts of the account are:

1. Trading Account: Trading account is the first part of this account, and it is used to determine the gross profit or loss of a business in a given period. It records all direct income and expenses related to buying and selling goods. 
2. Profit and Loss Account: It is the second part of the account which is used to determine the net profit or loss of a business.  It summarizes all revenues and expenses, helping businesses understand whether they are making money or running at a loss.

Let’s see both in detail.

Trading Account

• Trading account is used to determine the gross profit or gross loss of a business which results from trading activities. Trading activities are mostly related to the buying and selling activities involved in a business.
• Trading account is useful for businesses that are dealing in the trading business. This account helps them to easily determine the overall gross profit or gross loss of the business. The amount thus determined is an indicator of the efficiency of the business in buying and selling.
• The formula for calculating gross profit is: Gross profit = Net sales – Cost of goods sold. Where Net sales = Gross sales of the business minus sales returns, discounts and allowances.
• The trading account considers only the direct expenses and direct revenues while calculating gross profit.
• This account is mainly prepared to understand the profit earned by the business on the purchase of goods.
• Items that are seen in the debit side includes purchases, opening stock and direct expenses while credit side includes closing stock and sales.
• Trading account is prepared by closing all the temporary purchases and revenue accounts and making adjustments in the inventory accounts by the use of a closing journal entry.

Let’s see how to prepare a trading account-

The format of trading account after passing the closing entry will be as below:

Trading account for the year ended-

Particulars	Dr.	Particulars	Cr.
Sales returns	15,000	Sales	2,00,000
Purchases	45,000	Purchase returns	3,000
Opening inventory	10,000	Closing inventory	30,000
Balance c/d	1,63,000
Total	2,33,000	Total	2,33,000
Balance b/d= 1,63,000

 

Here all accounts are closed and transferred to the trading account. The credit entry of 1,63,000 is the gross profit for the period.

Profit and Loss Account

• Profit and loss account show the net profit and net loss of the business for the accounting period.
• This account is prepared in order to determine the net profit or net loss that occurs during an accounting period for a business concern.
• Profit and loss account get initiated by entering the gross loss on the debit side or gross profit on the credit side. This value is obtained from the balance which is carried down from the Trading account.
• A business will incur many other expenses in addition to the direct expenses. These expenses are deducted from the profit or are added to gross loss and the resulting value thus obtained will be net profit or net loss.

The examples of expenses that can be included in a Profit and Loss Account are:

1. Sales Tax
2. Maintenance
3. Depreciation
4. Administrative Expense
5. Selling and Distribution Expense
6. Provisions
7. Freight and carriage on sales
8. Wages and Salaries

These appear in the debit side of Profit and Loss Account while Commission received, Discount received, profit obtained on sale of assets appears on the credit side. Net profit can be determined by deducting business expenses from the gross profit and adding other incomes obtained. Net profit = Gross profit – Expenses + Other income

Difference between Trading and Profit and Loss Account

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