Trading Account

The very first financial statement prepared by an enterprise is a Trading Account. It is an account that is prepared to ascertain the trading results of a firm in form of gross profit earned or gross loss incurred during an accounting period. It is a nominal account in which all expenses or losses are debited and all incomes or gains are credited. On the debit side of this account purchases, opening stock, and all the direct expenses are shown. While on the credit side Sales and closing stock is shown. An important point to be noted here is that Trading Account records only direct expenses. These are those expenses that are directly related to the manufacturing and production of goods and services. The excess of credit side over its debit side is regarded as Gross Profit.

On the other hand, excess of debit side over its credit side is regarded as Gross Loss. The net result of this account i.e. gross profit or loss is transferred to the Profit and Loss Account. In the case of gross profit, it is transferred to the credit side of the Profit and Loss Account. In contrast, the gross loss is transferred to the debit side of the Profit and Loss Account.

Characteristics of Trading Account

The given below are some of the characteristics of a Trading Account.

Purposes of Trading Account

The given below are the purposes which are served by Trading Account.

Explanation of Items recorded in Trading Account

Items recorded on the Debit Side of Trading Account

Opening Stock: It is the stock of goods in hand at the beginning of the year. For a manufacturing concern, opening stock is comprised of opening raw materials, finished goods, and semi-finished goods (i.e. work-in-progress). Whereas for a trader opening stock includes various kinds of finished goods. It generally appears in the Trial Balance. For a newly set-up firm, there will be no opening stock. It is recorded on the debit side of the Trading Account.

Purchases: Purchases represent the various goods and services purchased during an accounting year. These goods are purchased either for further production or for the purpose of direct sale. Purchases include both cash purchases as well as credit purchases. It also includes the import of goods from foreign countries. It should be noted that the purchase of fixed assets is not included in these purchases. On the debit side of the Trading Account, the net purchases are shown. In order to get net purchases, we need to deduct the purchase return or return outwards from the gross purchases.

Apart from deducting the purchase returns from the purchases, the given below items are also required to be deducted from the purchases:

Goods withdrew for personal use i.e. drawings
Goods distributed as a free sample
Goods are given as charity

The given below are some items that should not be considered while recording the purchases in the Trading Account.

Goods-in-transit
Goods received on consignment
Goods received on sale or return basis

Direct Expenses: These are the expenses that are incurred in connection with the production or manufacturing of goods and services. It also includes the expenses incurred to bring the purchased goods to its place of business for the purpose of sale. Some of the examples are, carriage inwards, wages, custom duty, power, and fuel, etc. Let us discuss some of the direct expenses one by one.

Wages: The amount paid in form of wages to the workers engaged in the production or manufacturing units are regarded as direct expenses and are shown on the debit of the Trading Account. There may be a situation when a single amount is given in the Trial Balance for ‘Wages and Salaries’. In such a case, it should be treated as a direct expense and recorded in the Trading Account as salary may be paid to a worker engaged in the manufacturing process. On the other hand, if the word ‘Salaries and Wages’ is used for the amount in the Trial Balance, then it is regarded as an indirect expense and is not recorded in the Trading Account. An important point to be noted here is that if wages are paid for the installation of a new asset, then it is considered as capital expenditure and added to the cost of that asset. In simple words, it is not recorded in the Trading Account.

Carriage Inwards or Freight on Purchase: These are the expenses that are incurred to transport the goods from the supplier’s place to the firm’s place. These are the direct expenses and are recorded on the debit side of the Trading Account. It should be noted that any carriage or freight paid on acquisition of fixed assets are not considered as direct expenses and are not recorded in the Trading Account.

Power and Fuel: These are the cost of fuel, power, or gas that are incurred for running the plant and types of machinery used for the production of goods. These are shown on the debit side of the Trading Account.

Octroi: It is a kind of duty that is paid at the time of purchase of goods within the municipal
limits. It is also debited to the Trading Account.

Custom or Import Duty: These duties are paid at the time of purchase of goods from foreign countries. It is a direct expense and is shown on the debit side of the Trading Account.

Factory Lighting: The expenditure incurred to provide electricity/lights for factory premises to run the business activities is recognized as a direct expense and is shown on the debit side of the Trading Account.

Factory Rent and Rates: These are the expenses incurred in form of rent paid for the factory premises and municipal taxes. These are also shown on the debit side of the Trading Account.

Royalties: It is an expense incurred for the acquisition of patent rights. It is recognized as a direct expense and recorded on the debit side of the Trading Account.

Consumable Stores: These are the expenses incurred to keep the machine in the right condition. These include engine oil, oil grease, and waste, soft soap, etc. which are consumed in a factory.

Items recorded on the Credit Side of Trading Account

Sales: Sales represents the sales of goods and services made during the year. Sales include both cash sales as well as credit sales. It also includes the export of goods to foreign countries. It should be noted that the sale of fixed assets is not included in this sale. In the Trading Account, we show net sales on the credit side. In order to get net sales, we need to deduct the sales return or return inwards from the number of gross sales. But it should be noted that Sales does not include sales tax or value-added tax (VAT). Sales tax collected is a liability and is shown in the Balance Sheet. VAT collected is adjusted against VAT Paid and the balance is shown in the Balance sheet as a liability (if VAT collected is more) or Asset (if VAT paid is more).

Closing Stock: Closing stock represents the stock of goods i.e. raw materials, finished goods, and semi-finished goods (i.e. work-in-progress) that remained unsold at the end of the year. In other words, it is the stock of goods in hand at the end of an accounting year. For a manufacturing concern closing stock is comprised of closing raw materials, finished goods, and semi-finished goods (i.e. work-in-progress). Whereas, for a trader, it includes various kinds of finished goods. Closing Stock is recorded on the credit side of the Trading Account. Closing stock includes only stock of goods, whereas, the stock of stationery, postage, etc are excluded from it.

As per the accounting convention of conservatism the closing stock is recorded in the books at its ‘cost’ or ‘market value’ whichever is less. Generally, the closing stock is given outside the Trial Balance. In this case, the closing stock is recorded on the credit side of the Trading Account and is also shown on the Assets side of the Balance Sheet. But there may be a situation when closing stock is given inside the Trial Balance. In this case, it implies that the closing stock has already been adjusted in (or deducted from) the Purchases. That is, the Purchases given in the Trial Balance are adjusted purchases. Hence, there is no need to record Closing Stock separately in the Trading Account. It is shown only on the Balance Sheet.

Procedure to Prepare Trading Account

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