Trading account | Profit and loss account | Basics | Financial Statements | Class 11

Key Concepts

• Trading Account Format
• Direct Expenses
• Gross Profit/Loss
• Profit and Loss Account Format
• Indirect Expenses
• Net Profit/Loss
• Relationship between Trading and P&L Accounts

Trading Account Format

Opening Stock

• The trading account starts with the opening stock.

Purchases

• Purchases are listed in the inner column.
• Purchase returns are subtracted from purchases to get net purchases.
• Purchase returns are also known as "Return Outward."
  • The term "outward" signifies that goods are going out of the business, indicating a return.

Sales

• Sales are listed in the inner column.
• Sales returns are subtracted from sales to get net sales.
• Sales returns are also known as "Return Inward."
  • The term "inward" signifies that goods are coming back into the business, indicating a return.

Direct Expenses

• These are expenses directly related to production or purchase of goods.
• Four key indicators:
  • Related to factories
  • Related to production
  • Related to purchases
  • Expenses with the word "inward" (e.g., carriage inward)

Examples of Direct Expenses

• Wages: Paid for physical labor, typically in a factory setting.
  • If both "wages and salaries" are given, consider only the first word. If "wages" comes first, it's a direct expense.
• Carriage Inward/Carriage on Purchases: Transportation costs for bringing raw materials.
• Gas, Fuel, and Power: Used in the factory for production.
• Freight and Cartage: Costs associated with transporting goods.
• Manufacturing Expenses: Any expenses related to the manufacturing process.
• Factory Expenses: Rent, light, etc., specifically for the factory.
• Dock Charges: Expenses for goods arriving via ship.
• Import Duty/Custom Duty: Taxes on goods imported from foreign countries.
• Royalty: Payment for using an asset, such as extracting coal from a mine.

Closing Stock

• Listed on the credit side of the trading account.

Gross Profit/Loss Calculation

• The difference between the debit and credit sides determines the gross profit or gross loss.
• If the credit side is greater, the difference is gross profit.
• If the debit side is greater, the difference is gross loss.

Profit and Loss Account Format

Relationship with Trading Account

• The P&L account is an extension of the trading account.
• It starts where the trading account ends.

Scope

• Includes expenses not covered in the trading account, such as:
  • Office expenses
  • Selling expenses
  • Administration expenses
  • Other expenses (e.g., bad debts, depreciation)
• Also includes incomes.

Basic Principles

• All expenses and losses are debited (Debit All Expenses and Losses).
• All incomes and gains are credited (Credit All Incomes and Gains).
• It follows the rules of a nominal account.

Format Details

Gross Profit/Loss Transfer

• If there's a gross profit from the trading account, it's transferred to the credit side of the P&L account as "By Gross Profit Brought Down."
• If there's a gross loss, it's transferred to the debit side as "To Gross Loss Brought Down."

Indirect Expenses

• Expenses not directly related to production.

Examples of Indirect Expenses

• Salaries: Paid for mental labor.
  • If both "salaries and wages" are given, consider only the first word. If "salaries" comes first, it's an indirect expense.
• Rent, Rates, and Taxes: Office-related expenses.
• Printing and Stationery: Office supplies.
• Postage and Telegrams: Communication expenses.
• Lighting: Office lighting.
• Insurance: Business insurance.
• Telephone Expenses: Communication costs.
• Legal Charges: Legal fees.
• Audit Fees: Fees paid to a chartered accountant for verifying financial statements.
• Traveling Expenses: Business travel costs.
• Establishment Expenses: Costs for setting up the business.
• General Expenses: Miscellaneous office expenses.
• Carriage Outward: Transportation costs for delivering goods to customers.
• Advertising: Marketing expenses.
• Commission Paid: Commission given to sales agents.
• Brokerage Paid: Fees paid to brokers.
• Export Duty: Taxes on exported goods.
• Packing Charges: Costs for packing goods for sale.
• Delivery Van Expenses: Costs for operating delivery vehicles.
• Stable Expenses: Expenses related to maintaining stables (if applicable).
• Discount Allowed: Discounts given to customers.
• Repairs: Maintenance costs.
• Depreciation: Reduction in the value of assets.
• Interest Paid: Interest on loans.
• Bank Charges: Fees charged by the bank.
• Entertainment Expenses: Business entertainment costs.
• Conveyance: Transportation expenses.
• Donation and Charity: Charitable contributions.
• Loss on Sale of Asset: Loss incurred when selling an asset.

Incomes

• Incomes not directly related to sales.

Examples of Incomes

• Rent Received: Income from renting out property.
• Discount Received: Discounts received from suppliers.
• Commission Received: Commission earned.
• Interest Received: Interest earned on investments.
• Dividend Received: Income from shares in a company.
• Bad Debt Recovered: Money recovered from previously written-off bad debts.
• Profit on Sale of Asset: Profit earned when selling an asset.
• Income from Other Sources: Miscellaneous income.

Net Profit/Loss Calculation

• The difference between the debit and credit sides determines the net profit or net loss.
• If the credit side is greater, the difference is net profit.
• If the debit side is greater, the difference is net loss.

Synthesis/Conclusion

The trading account determines the gross profit or loss by considering direct revenues and expenses related to production and sales. The profit and loss account then extends this by incorporating indirect revenues and expenses to arrive at the net profit or loss, providing a comprehensive view of the business's overall profitability. The net profit from the P&L account is a key indicator of the company's financial performance.