Operations and Profit and Loss Account

trading account

As already discussed, the first section of the trading and profit and loss account is called the trading account. The purpose of preparing the trading account is to find out the gross profit or gross loss, while that of the second section is to find out the net profit or net loss.

Business Account Preparation

The commercial account is prepared mainly to find out the profitability of the purchased (or manufactured) goods sold by the entrepreneur. The difference between the selling price and the cost of goods sold is the entrepreneur’s profit. Therefore, to calculate the gross profit, it is necessary to know:

(a) cost of goods sold.

(b) dirty.

Total sales can be determined from the sales ledger. However, the cost of goods sold is calculated. To calculate the cost of sales it is necessary to know its meaning. The ‘cost of goods’ includes the purchase price of the goods plus expenses related to buying the goods and moving the goods to the place of business. To calculate the cost of goods, we must deduct from the total cost of goods purchased the cost of goods on hand. We can study this phenomenon with the help of the following formula:

Beginning stock + cost of purchases – closing stock = cost of sales

As already discussed, the purpose of preparing a business account is to calculate the gross profit of the business. It can be described as an excess of the ‘Sales’ amount over the ‘Cost of Sales’. This definition can be explained in terms of the following equation:

Gross Profit = Sales-Cost of Goods Sold or (Sales + Closing Stock) – (Initial Stock + Purchases + Direct Expenses)

Beginning stocks and purchases, along with purchase and delivery charges (direct charges), are recorded on the debit, while sales and ending stocks are recorded on the credit. If the credit side is better than the debit side, the difference is written on the debit side as gross profit, which is eventually recorded on the credit side of the profit and loss account. When the debit side exceeds the credit side, the difference is a gross loss that is recorded on the credit side and ultimately shown on the debit side of the profit and loss account.

Common elements in a business account:

A) Flow side

1. Initial stock. It is the stock that remained unsold at the end of the previous year. It must have been brought to the books with the help of the opening entry; so it always appears within the trial balance. It is usually displayed as the first item on the debit side of the business account. Of course, in the first year of a business there will be no beginning stock.

2. Shopping. It is normally the second item on the debit side of the business account. ‘Purchases’ means total purchases, ie cash purchases plus credit. Any return to the outside (return of purchases) must be deducted from the purchases to know the net purchases. Sometimes the goods are received before the corresponding invoice from the supplier. In such a situation, an entry should be made on the date of preparation of the final accounts to debit the purchases account and credit the suppliers account with the cost of the goods.

3. Purchase expenses. All expenses related to the purchase of goods are also charged to the trading account. These include wages, freight inland transportation, tariffs, clearance charges, port charges, excise duties, attribution and import duties, etc.

4. Manufacturing Expenses. Entrepreneurs incur such expenses to make or bring the goods into salable condition, namely motive power, gas fuel, shops, royalties, factory expenses, salary of foreman and supervisor, etc.

Although the manufacturing expenses should be taken strictly in the manufacturing account, since we are preparing only a business account, the expenses of this type can also be included in the business account.

(B) Credit side

1. Dirty. Sales means total sales, that is, cash sales plus credit. If there are sales returns, they should be deducted from the sales. The net sales are then credited to the trading account. If a business asset has been sold, it should not be included in the sales.

2. Closing stock. It is the value of the stock remaining unsold in the shop or store on the last date of the accounting period. Normally, the closing stock is given out of the trial balance, in that case, it is shown on the credit side of the trading account. But if it occurs within the trial balance, it should not be shown on the credit side of the trading account, but instead appears only on the balance sheet as an asset. Closing inventories should be valued at cost or market price, whichever is lower.

Closing Stock Valuation

To determine the value of the closing stock, it is necessary to make a complete inventory or list of all items owned by God along with the quantities. Based on physical observation, stock lists are prepared and the total stock value is calculated based on unit value. So it is clear that inventory implies (i) inventory, (ii) pricing. Each item has a cost price, unless the market price is lower. Pricing inventory at cost is easy if cost remains fixed. But prices keep fluctuating; therefore, stock valuation is done on the basis of one of many valuation methods.

The preparation of the trading account helps the trade to know the relationship between the costs incurred and the income obtained and the level of efficiency with which the operations have been carried out. The relationship between gross profit and sales is very significant: we arrive at:

Gross Profit X 100 / Sales

With the help of the GP ratio, you can determine how efficiently you are running the business, the higher the ratio, the better the efficiency.

Closing entries belonging to the commercial account

For the transfer of various accounts related to goods and purchase expenses, the following closing entries are recorded:

(i) For opening actions: commercial debit account and credit actions account

(ii) For purchases: Debit merchant account and credit purchase account, the amount being the and the amount after deducting the purchase returns.

(iii) For purchase returns: Debit purchase return account and credit purchase account.

(iv) For inward returns: sales debit account and credit sales return account

(v) For direct expenses: Debit from the trading account and credit from the direct expense accounts individually.

(vi) For sales: sales debit account and credit trading account. We will find that all accounts as mentioned above will be closed with the exception of the trading account

(vii) For Closing Actions: Debit Closing Actions Account and Credit Trading Account After recording the above entries, the trading account will be balanced and the difference of two sides will be determined. If the credit side is plus, the result is the gross profit for which the next entry is recorded.

(viii) For gross profit: Debit trading account and credit profit and loss account. If the result is a gross loss, the previous entry is reversed.

Profit and loss account

The profit and loss account is opened by recording the gross profit (on the credit side) or the gross loss (on the debit side).

To make a net profit, an entrepreneur has to incur many more expenses besides direct expenses. Those expenses are deducted from the profit (or added to the gross loss), the resulting figure will be the net profit or the net loss.

Expenses that are recorded in the profit and loss account are called ‘indirect expenses’. These will be classified as follows:

Sales and distribution expenses..

These include the following expenses:

(a) Salary and commission of sellers.

(b) Commission to agents

(c) Freight and transportation in sales

(d) Sales tax

(e) Bad debts

f) Advertising

g) Packaging costs

h) Export duties

Administrative expenses.

These include:

(a) Office salaries and wages

(b) Insurance

(c) Legal expenses

(d) Business expenses

(e) Fees and taxes

f) Audit fees

g) Insurance

h) Income

(i) Printing and stationery

(j) Posts and telegrams

k) Bank charges

Financial expenses

These included:

(a) Discount allowed

(b) Interest on Principal

(c) Interest on loans

(d) Charges for discount on the discounted invoice

Maintenance, Amortizations and Provisions etc..

These include the following expenses

(a) Repairs

(b) Asset depreciation

(c) Provision or reserve for bad debts

(d) Reserve for discount to debtors.

Along with the above indirect expenses, the debit side of the profit and loss account also comprises various business losses.

On the credit side of the profit and loss account, the items recorded are:

(a) Discount received

(b) Commission received

(c) Income received

(d) Interest received

(e) Investment income

(f) Profit on sale of assets

(g) Bad Debt Recovery

(h) Dividend received

(i) Premium Learning, etc.

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