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Trading and Profit and Loss Account: Opening Journal Entries

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  • Last Updated : 01 Jul, 2022
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Each business wants to know the operating results (profits) from its operations. The last step of the accounting cycle is to analyse the Gross Profit of the business followed by Net profit. To determine the Gross Profit, Trading Account is prepared, and for Net Profit, Profit and Loss Account is prepared. Although these are two separate accounts, but are prepared together in general ledger as part of final financial statements.

Trading Account:

The purpose of this account is to determine the gross profit/(loss) of a business from its trading activities. Trading activities are generally the buying and selling activities of business (mainly goods). It is a nominal account where all the expenses related to the purchase of goods or manufacturing of goods are debited, and net sales along with closing stock is credited. The businesses involved in trade need to understand their profitability from core activities before the overall profits, and that is where a trading account has its relevance. The trading account considers only the direct expenses and direct revenues while calculating gross profit. The overall gross profit/(losses) determined is an indicator of efficiency of the business in buying and selling.
 

Gross Profit can be calculated as:

Gross profit = Net Sales – Cost of Goods Sold

where, 

Net Sales = Cash Sales + Credit Sales – Sales Return

Cost of Goods Sold = Opening Inventory + Net Purchases + Direct Expenses- Closing Inventory

Closing entries for Trading A/c:

The various nominal accounts showing debit and credit balances which are related to Trading A/c are closed and transferred to Trading A/c. 

Journal Entry:

1. For Accounts having Debit Balance:

 

2. For Accounts having Credit Balance:

 

3. For Gross Profit/Gross Loss:

  • For Gross Profit: (If Credit side is more)

 

  • For Gross Loss: (If Debit side is more)

 

Illustration: 

ABC Co. Ltd. is a trading firm dealing in sales of car batteries. In Financial Year 2021-22, ABC trading firm has made sales of ₹10,00,000, out of which ₹50,000 has been returned due to quality issues. The firm had an opening stock of ₹1,00,000 and left with closing inventory of ₹1,50,000. ABC Co. has made purchases of ₹5,00,000, of which ₹1,00,000 has been returned to vendor due to some issues. The transportation cost of bringing in the batteries has been borne by ABC Co. of ₹50,000. Calculate gross profit/(losses) of ABC Co. for FY 2021-22.

Solution:

 

Profit and Loss Account:

After preparing Trading A/c where all the items directly related to production or purchase of goods are adjusted, businesses prepare Profit & Loss A/c. Profit & Loss A/c shows the overall profitability (Net Profit) of the business considering non-trading expenses and incomes of the business. This account begins where the trading account ends. The balance of Gross Profit/ Gross Loss is carried down as starting point to adjust various expenses and incomes, determining net profit. 

Some of the items that are seen on the debit side of the Profit and Loss Account include wages and salaries, insurance, audit fees, electricity charges, depreciation, rent, telephone expenses, repair and maintenance, interest on loans, etc., and a few examples of credit side items are discount received, commission received, bank interest, rent received, dividend on shares, etc.

Net profit can be determined by deducting business expenses from the gross profit and adding other incomes obtained.
 

Net profit = Gross Profit  + Other Income – Expenses

Closing Entries for Profit & Loss Account:

The various nominal accounts showing debit and credit balances, which are related to Profit & Loss A/c are closed and transferred to Profit & Loss A/c. 

1. For Accounts having Debit Balance:

 

2. For Accounts having Credit Balance:

 

3. For Net Profit/Net Loss:

  • For Net Profit: (If Credit side is more)

 

  • For Net Loss: (If Debit side is more)

 

Illustration:

ABC Co. Ltd. has earned a Gross Profit of ₹5,50,000 for the financial year 2021-22. The company paid Rent of ₹20,000, Electricity (Office) ₹5,000, Wages to Employee ₹50,000, Interest on Loan ₹35,000, Audit Fees ₹5,000, and Insurance ₹30,000 in that year. Depreciation charges for the year is ₹15,000. Also, the firm received Bank Interest ₹5,000 and Commission on Sales of ₹40,000. Calculate Net profit/ Net Loss for FY 2021-22.

Solution:

 


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