- Define and explain trading account. (What is trading Account ?)
- What are the items of a trading account.
- Prepare the format of trading account.
- What are advantages of trading accounting?
Definition and Explanation:
A trading account is an account which contains, ” in summarized form, all the transactions, occurring, throughout the trading period, in commodities in which he deals” and which gives the gross trading result. In short, trading account is the account which is prepared to determine the gross profit or the gross loss of a trader.
Items of Trading Account:
The following items usually appear in the debit and credit sides of the trading account.
Debit Side Items:
- The value of opening stocks of goods (i.e., the stock of goods with which the business was started).
- Net purchase made during the year (i.e., purchases less returns).
- Direct expenses, if any.
Credit Side Items:
- Total sales made during the period less the value of returns, i.e., net sales.
- The value of closing stock of goods.
The difference between the two sides of the trading account represents either gross profit or gross loss. Thus if the credit side is heavier that would mean that the trader has earned gross profit i.e., the excess of selling price of the goods sold over their purchase price. If the debit side is heavier it would mean that the trader has suffered gross loss i.e., purchase price of goods exceeds the selling price.
The balance of trading account which represents either gross profit or gross loss is transferred to profit and loss account.
Format of Trading Account (T or Account Form):
For the year ending …….20……
Trading Accounts Items:
Now we shall discuss the items of trading account one by one.
In case of trading concerns it will consist of only finished goods or goods to be sold without alteration. In manufacturing concerns, the opening stock will consist of three parts
(a). Stock of raw materials.
(b). Stock of partly completed goods or work-in-progress.
(c). Stock of finished goods.
In case of new business there will be no opening stock.
This item includes both cash and credit purchases of goods bought with the object of sales.
Return Outwards or Purchases Returns:
It means the goods returned by a trader to his suppliers from out of his purchases. Return outwards reduce the purchases. It is shown by way of deduction from purchases in the trading account.
Discount on Purchases:
It is also shown by way of deduction from purchases in the trading account.
This item includes total of both cash and credit sales of goods in which businessman deals in. It is credited to trading account.
Returns Inwards or Sales Returns:
It means goods returned to a trader by his customers from out of goods sold to them. It is shown by way of deduction from sales on the credit side, of the trading account.
Discount on Sales:
This account has always a debit balance and is shown by deduction from sales in the trading account.
Direct expenses are those expenses which are incurred to convert raw-materials into finished goods or which may be regarded as a part of the cost of purchasing the goods. e.g., wages paid by a manufacturer to construct furniture out of raw wood, the expenses incurred to bring goods from the place of purchase to the business place of the trader etc. All the direct expenses are charged to the trading account. The items usually included in the direct expenses are:
Wages: This item usually signifies some hourly, daily or piecework remuneration paid to laborers. It is direct expenditure and should be charged to trading account.
Manufacturing or Productive Wages: This item usually signifies the wages of factory workmen actually engaged in making or producing something. It is a direct charge on the cost of manufacturer. It is debited to manufacturing account or trading account.
Carriage Inward: Carriage means conveyance charges of goods by land. Carriage inward are the conveyance expenses incurred to bring the goods purchased in the godown or shop. It is debited to trading account. In examination questions when the item only “carriage” is given and is not expressly stated to be inward or outward, it should be assumed to be inward and debited to trading account. The reason is that carriage on goods is usually paid by the purchaser.
Cartage: The cartage charges on goods purchased are direct expenses and should be debited to trading account.
Freight: Freight is the charge made for conveyance of goods by sea. Freight on goods purchased is charged to trading account.
Customs Duty, Octroi Duty etc: When goods are purchased from a foreign country import duty will be payable. When goods are received from another city, the municipal corporation may charge octroi duty. All duties on goods purchased should be debited to trading account.
Excise Duty: It is a tax levied by the government. If the duty is levied on production it will be treated as manufacturing expenses and debited to trading account.
Stores Consumed: This item stores denote lubricating oil, tallow, grease, cotton and jute waste, etc., required for running the machinery of manufacturing concern. The amount of stores consumed is a direct expense and should be charged to trading account.
Motive Power: This item includes, coke, gas, water or electric energy consumed in propelling the machinery. It is debited to manufacturing account in the absence of a manufacturing account, it is debited to trading account.
Royalty: Royalty is an amount paid to a person for exploiting rights possessed by him it is usually paid to patentee, author, or landlord for the right to use his patent, copyright or land. If they are productive expenses, they are debited to manufacturing account; but in the absence of a manufacturing account, they are debited to trading account.
Manufacturing Expense: All other expenses such as factory rent, factory insurance, factory repair etc., are direct expenses and should be charged to trading account.
Closing Stock and its Valuation:
Closing stock represents the value of goods lying unsold in the hands of a trader at the end of a trading period. The value of closing stock is ascertained by means of compilation of list of materials, stores and goods actually in possession at the close of the trading period. This work is known as taking the inventory. The inventory or lists of physical stock are then faired and valued. The total of the lists will be closing stock. The closing stock is valued at cost or market price whichever is lower. As this item materially affects the gross profit (or gross loss), it is essential that all possible care should be taken to calculate the closing stock at a proper value.
The value of closing stock is taken into consideration only at the time of preparing the trading account and not before. The trial balance is prepared before the preparation of the trading account. Hence the closing stock does not appear in a trial balance. It is brought into account by means of a journal entry debiting stock account and crediting the trading account.
Closing Entries for Trading Account:
Closing entries are those which are passed at the end of each financial period for the purpose of transferring the various revenues items to the trading and profit and loss account and thus the nominal accounts are closed. I preparing a trading account, the opening stock, purchases, sales, returns both inwards and outwards, direct expenses and closing stock are transferred to it by means of journal entries as follows:
To Purchases Account
To Returns Inwards Account
To Direct Expenses Account (wages, carriage etc.)
(Being the transfer of the latter accounts to the former.)
Returns Outward Account
To Trading Account
(Sales etc., transferred to trading account)
Closing Stock Account
To Trading Account
(Being to record closing stock)
Advantages of Trading Account:
The advantages of the trading account are as follows:
A trader can find out the gross profit and thereby can ascertain the percentage of profit he has earned on the cost of goods sold. This percentage of gross profit may serve as his ready guide for the adjustment of future sale price.
A trading account help a trader to compare his stock at open with that at the close. He can further find out whether the purchases he has made during the period of account have been judicious.
Once can compare the figure of sales with similar figure of the previous year and can find out whether business is improving or declining.
If the gross profit disclosed by the trading account is less than expected, an enquiry can be made into the cause responsible for the decline. And if the gross profit is more than was expected, steps can be taken to maintain it.
You may also be interested in other articles from “final accounts” chapter:
- Trading Account
- Profit and Loss Account
- Difference Between Trading Account and Profit and Loss Account
- Balance Sheet
- Difference Between Trial Balance and Balance Sheet
- Examples of Trading and Profit and Loss Account and Balance Sheet
Other Related Accounting Articles:
- Profit and Loss Account in Statement Form/Income Statement
- Difference Between Trading Account and Profit and Loss Account
- Distinction/Difference Between Trial Balance and Balance Sheet
- Final Accounts
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