It is very clear from the title ‘trading and profit and loss account’, that it is divided in two parts. First part is called as trading account and the second part is called as profit and loss account. The main purpose to prepare trading account is as under:-

  1. To know the gross profit or gross loss of the business.
  2. Whether the material cost and the direct expenses are covered or no. Material cost means the cost of items used to produce the goods for sale and direct expenses means the expenses directly related to the production to make the goods for salable purpose.

Benefits of preparing a Trading Account

  1. By preparing the trading account can make certain decisions in respect of saving the cost of material and direct expenses to increase more profitability.
  2. The rates of products also can be decided after having the idea of gross profit or gross loss. It should be noted that no firm can run the business for a longer period if it is running into gross loss.
  3. Comparison of gross profit can be done to know the improvement.
  4. Stock can be controlled.

Trading account is a statement which is prepared with the help of the trial balance. All the debit items relating to trading account are written in debit side of trading account and all credit items relating trading account are written in credit side of trading account. It contains four columns:-

  1. Expenditure
  2. Amount Dr.
  3. Income
  4. Amount Cr.

Following items are shown in expenditure column and the related amount is shown in Amount Dr. Column:-

  1. Opening stock
  2. Purchases minus purchase returns.
  3. Wages to worker, directly involved in production.
  4. Duties and taxes paid on purchases which are not supposed to be claimed by the firm in either way.
  5. Freight, cartage paid on purchases.
  6. Royalty amount paid
  7. Gas, electricity, oil, coal and other fuel charges
  8. Rent of factory
  9. Salary of factory staff who is directly involved in production.
  10. Consumable stores
  11. Packing material and charges for making the goods for salable purpose.

Following items are shown in income side of trading account and the amount to be shown in Cr. column of the respective items:-

  1. Sales minus sales return.
  2. Sale of by product
  3. Sale of scrap relating to the produced items.
  4. Closing stock. Closing stock is not shown in trial balance but is shown as footnote in trial balance.

After putting the Income and expenditure items, the balance of trading account is done. If the total of credit side is more than the debit side then the amount of difference indicates the gross profit. If the total of debit side is more than credit side then the amount of difference indicates the gross loss.