Trading and Profit and Loss Account

A business needs to prepare a trading and profit and loss account 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.

The motive of preparing a trading and profit and loss account is to determine 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

2. Profit and Loss Account

Trading account is the first part of this account and it is used to determine the gross profit that is earned by the business while the profit and loss account is the second part of the account which is used to determine the net profit of the business.

Let us know more about these accounts in detail

1. 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 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 formulae for calculating gross profit is as follows:

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 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.

Closing entries for Gross Loss or Gross Profit

The following entries are passed in case of Gross Loss

Profit and Loss A/c – Dr.

To Trading A/c

While in the case of Gross Profit

Trading A/c -Dr.

To Profit and Loss A/c

Preparing Trading Account

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

Account Debit Credit
Sales 205,000
Sales returns 15,000
Purchases 49,000
Purchase returns 3,000
Beginning inventory 8,000
Ending inventory 9,000
Trading Account 145,000
Total 217,000 217,000
In this example all accounts are closed and transferred to the trading account. The credit entry of 145,000 is the gross profit for the period.

The format of trading account after passing the closing entry is as follows:

Trading Account
Debit Credit
Sales returns 15,000 Sales 205,000
Purchases 49,000 Purchase returns 3,000
Beginning inventory 8,000 Ending inventory 9,000
Balance c/d 145,000
Total 217,000 Total 217,000
Balance b/d 145,000

2. 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 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 appear 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

Closing Entries for Net Loss or Net Profit:

i. In case of Net Loss

Capital A/c – Dr.

To Profit and Loss A/c

ii. In case of Net Profit

Profit and Loss A/c -Dr.

To Capital A/c

Trading and Profit and Loss Account Format

Trading and Profit and Loss Account format is represented separately as follows:

Format for Trading Account

Trading Account Format

Format for Profit and Loss Account

Profit and Loss Account Format

Difference between Trading and Profit and Loss Account

The following points of difference exists between the Trading and Profit and Loss Account

Basis of Comparison

Trading Account

Profit and Loss Account

Meaning Trading account used to find the gross profit/loss of the business for an accounting period. Profit and loss account or Income statement is used to find the net profit/loss of the business for an accounting period.
Timing  Trading Account is prepared first and then profit and loss account is prepared. Profit/Loss Account is prepared after the trading account is prepared.
Purpose  For knowing the gross profit or gross loss of a business For knowing the net profit or net loss of a business
Stage It is the first stage in the creation of the final account. it is the second stage in the creation of the final account.
Dependency It is not dependent on trial balance It is dependent on trading account
Transfer of Balance  The balance in the form of Gross loss or Gross Profit of the trading account will be transferred to the Profit and Loss Account The balance in the form of Net loss or Net Profit of the profit and loss account will be transferred to the Balance Sheet

This article covers all the aspects of the Trading and Profit and Loss Account. It will help the students form a clear idea about the Trading and Profit and Loss Account and its use in accounting. For more such interesting concepts of Commerce stay tuned to BYJU’S.

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  1. Concepts explained in an easy-to-understand style.

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