Trading Profit and Loss Account

The trading profit and loss account is made up of two separate accounts within the general ledger.

  1. The trading account
  2. The profit and loss account

The purpose of the two accounts is to separately identify the gross profit and net profit of the business. The trading account is the top part of the trading profit and loss account and is used to determine the gross profit. The profit and loss account is the lower part of the trading profit and loss account and is used to determine the net profit of the business.

trading profit and loss account
 

The trading and profit and loss accounts are discussed in more detail below.

The Trading Account

The trading account is particularly useful for a merchandising business or trading business involved in the buying and selling of finished products. The account allows the merchandiser to easily determine its overall gross profit and gross profit percentage which are important indicators of how efficiently a business is buying and selling its products.

Trading Account Formula

The trading account shows the gross profit which is determined by deducting the cost of goods sold from the net sales revenue of the business.

The gross profit is calculated using the trading account formula.

Gross profit = Net sales – Cost of goods sold

In the formula net sales is equal to the gross sales of the business less sales returns, allowances, and discounts.

It should be noted that carriage outwards is not included in the trading account. Carriage outwards is an expense included in the profit and loss account discussed below.

The cost of goods sold used in the formula can be expanded using the following formula.

Cost of goods sold = Net purchases + Beginning inventory – Ending inventory

Net purchases is equal to the gross purchases of the business including carriage inwards less any purchase returns, allowances, and discounts.

Preparation of Trading Account

The trading account is prepared by closing the temporary revenue and purchases accounts and adjusting the inventory accounts using a closing journal entry as shown in the example below.

Trading account closing journal entry
Account Debit Credit
Sales 105,000
Sales returns 5,000
Purchases 49,000
Purchase returns 3,000
Beginning inventory 8,000
Ending inventory 9,000
Trading Account 55,000
Total 117,000 117,000

Each account is closed and transferred to the trading account. The credit entry to the trading account of 55,000 represents the gross profit for the period.

Trading Account Example

After the closing journal entry has been posted the trading account would take the format shown in the example below.

Trading account after closing journal entry
Trading Account
Debit Credit
Sales returns 5,000 Sales 105,000
Purchases 49,000 Purchase returns 3,000
Beginning inventory 8,000 Ending inventory 9,000
Balance c/d 55,000
Total 117,000 Total 117,000
Balance b/d 55,000

For clarity, in this example each line item is posted to the general ledger trading account leaving a credit balance brought down of 55,000 which represents the gross profit of the business.

In the example above the trading account has a net credit balance of 55,000 which indicates sales are greater than the cost of goods sold and the business has made a gross profit. If the trading account had a net debit balance brought down it would indicate (unusually) that sales were less than the cost of goods sold and the business had made a gross loss.

Trading Account in Final Accounts

In the final accounts the trading account is usually presented in a more readable format. Assuming the figures relate to the month ended 31 December an example of a trading account might appear as follows.

Trading account for the month ended December 31 2017
Net sales 100,000
Net purchases 46,000
Beginning inventory 8,000
Ending inventory -9,000
Cost of goods sold 45,000
Gross profit 55,000

Again the trading account shows the gross profit of 55,000 the business made on the products it buys and sells.

In addition since the trading account shows the net sales the gross profit percentage can be easily calculated as follows.

Gross profit % = Gross profit / Net sales
Gross profit % = 55,000 / 100,000 = 55%

The Profit and Loss Account

The profit and loss account is used to determine the net profit of the business. The starting point for the profit and loss account is the balance carried down from the trading account which is the gross profit of the business.

Profit and Loss Account Formula

The profit and loss account shows the net profit which is the determined by deducting the expenses of the business from the trading account gross profit and adding other income.

The net profit is calculated using the profit and loss account formula.

Net profit = Gross profit – Expenses + Other income

In the above formula expenses refers to all the costs of the business which are not included in cost of goods sold in the trading account such as wages and salaries, rents, insurance, bank charges etc.

Other income refers to any income other than that included in sales revenue such as interest received.

Preparation of Profit and Loss Account

The profit and loss account is prepared by closing the trading account, expense accounts and other income accounts using a closing journal entry.

Profit and loss account closing journal entry
Account Debit Credit
Trading Account 55,000
Expense accounts 48,000
Other income 5,000
Profit and Loss Account 12,000
Total 60,000 60,000

Each account is closed and transferred to the profit and loss account in the general ledger. The credit entry to the profit and loss account of 12,000 represents the net profit for the period.

Profit and Loss Account Example

After the closing journal entry has been posted the profit and loss account would take the format shown in the example below.

Profit and loss account after closing journal entry
Profit and loss account
Debit Credit
Gross profit b/d 55,000
Expenses 48,000 Other income 5,000
Balance c/d 12,000
Total 60,000 Total 60,000
Balance b/d 12,000

Again for clarity, in this example each line item is posted to the general ledger profit and loss account leaving a credit balance brought down of 12,000 representing the net profit of the business.

In the example above the profit and loss account has a net credit balance of 12,000 which indicates sales and other income are greater than the cost of goods sold and expenses and the business has made a net profit. If the profit and loss account had a net debit balance brought down it would indicate that sales and other income were less than the cost of goods sold and expenses and the business had therefore made a net loss for the accounting period.

Profit and Loss Account in the Final Accounts

The profit and loss account starting with gross profit is not usually shown as a separate statement and is normally combined with the trading account and shown as a combined trading profit and loss account format shown later in this post.

For the sake of completeness, assuming the figures relate to the month ended 31 December, a separate profit and loss account starting with gross profit might appear as follows.

Profit and loss account for month ended December 31 2017
Gross profit 55,000
Expenses 48,000
Other income 5,000
Net profit 12,000

Again the profit and loss account shows the net profit of 12,000 the business has made for the accounting period.

Using the net sales from the trading account the business can quickly calculate the net profit percentage as follows.

Net profit % = Net profit / Net sales
Net profit % = 12,000 / 100,000 = 12%

Trading Profit and Loss Account Format

The trading account and the profit and loss account can be combined into a single summary known as a trading profit and loss account.

An example trading profit and loss account format is shown below.

Trading profit and loss account format – month ended December 31 2017
Net sales 100,000
Net purchases 46,000
Beginning inventory 8,000
Ending inventory -9,000
Cost of goods sold 45,000
Gross profit 55,000
Expenses 48,000
Other income 5,000
Net profit 12,000

By using the trading profit and loss account the merchandising business can clearly see both the gross and net profit of the business and can quickly calculate the gross and net profit percentages based on net sales.

Trading Profit and Loss Account July 31st, 2018Team

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