Trading & Profit/Loss Account

Learning Objective: Prepare a trading and profit & loss account

At the end of each financial year, every business needs to answer two key questions: How much did we earn from selling goods? And after paying all expenses, how much profit (or loss) is left? A handicraft shop in Thamel, Kathmandu, might have sold goods worth Rs. 15,00,000 during the year -- but that does not mean all of it is profit. The Trading and Profit & Loss Account reveals the true picture.

Trading Account

The trading account calculates gross profit (or gross loss) by comparing sales revenue with the cost of goods sold (COGS).

Formula: Gross Profit = Net Sales - Cost of Goods Sold

Cost of Goods Sold (COGS) = Opening Stock + Purchases + Direct Expenses - Closing Stock

Example: Himalayan Handicrafts, Kathmandu (Year ending 2081 Chaitra)

| Dr. Trading Account Cr. | | | | |---|---|---|---| | To Opening Stock | Rs. 1,20,000 | By Sales | Rs. 8,50,000 | | To Purchases | Rs. 4,50,000 | By Closing Stock | Rs. 1,50,000 | | To Carriage Inward | Rs. 15,000 | | | | To Wages | Rs. 35,000 | | | | To Gross Profit c/d | Rs. 3,80,000 | | | | Total | Rs. 10,00,000 | Total | Rs. 10,00,000 |

Profit & Loss Account

The profit and loss account takes the gross profit and subtracts all indirect expenses (operating expenses) to arrive at net profit.

Formula: Net Profit = Gross Profit + Other Income - Indirect Expenses

| Dr. Profit & Loss Account Cr. | | | | |---|---|---|---| | To Salaries | Rs. 1,20,000 | By Gross Profit b/d | Rs. 3,80,000 | | To Rent | Rs. 60,000 | By Commission Received | Rs. 10,000 | | To Electricity | Rs. 18,000 | | | | To Advertising | Rs. 12,000 | | | | To Net Profit | Rs. 1,80,000 | | | | Total | Rs. 3,90,000 | Total | Rs. 3,90,000 |

Key Adjustments

When preparing final accounts, certain adjustments are necessary:

• Closing Stock: Added to the credit side of the Trading Account
• Outstanding Expenses: Expenses incurred but not yet paid (e.g., unpaid salary)
• Prepaid Expenses: Expenses paid in advance for the next period
• Depreciation: Reduction in value of fixed assets
• Bad Debts: Amounts owed by customers that cannot be recovered

Key Term: Gross Profit is the profit earned from buying and selling goods before deducting operating expenses. Net Profit is the final profit after all expenses are deducted.

Summary

• The Trading Account shows gross profit by matching sales with cost of goods sold.
• The Profit & Loss Account shows net profit by deducting indirect expenses from gross profit.
• Adjustments like closing stock, depreciation, and outstanding expenses must be accounted for.
• These statements help businesses assess their profitability each year.