What is Trading Account in Accounting?
Trading Account is the first step in preparing final accounts or financial statements. It is prepared to know the trading activities conducted for any year in the business firm. Also, it is useful to know the gross profit/loss made by a trader during the year.
Here, Gross profit is the difference between the Sales price and the Cost of goods sold.
The sales price is the difference between Sales Value and Sales return Value.
The Cost of goods sold is the cost incurred to make the sales. It is the cost of total sales made for any trader.
Cost of goods sold = (opening stock+purchases+direct expenses) - closing stock
What are the Characteristic features of a Trading Account in accounting?
The following are the features as given below.
1. One of the main features is that it is a Nominal Account. Here, all the direct expenses, opening stock and purchases will be recorded on the debit side. All the direct incomes, sales, and closing stock will be recorded on the credit side. This is as per the golden rules of the double entry system. We debit all expenses/ losses and credit incomes/gains/revenues for Nominal Accounts. For example, purchases made for 1000$ will be treated as a direct expense. Purchases will be debited with their respective amounts. Similarly, sales made for 1500$ will be a direct income. Sales will be credited with their respective amounts.
2. It is one of the financial statements. Financial statements are the reports that convey the financial performance and position of a business concern. It is the first step towards the preparation of final accounts for a trader. It is the second step in final accounts preparation for a manufacturer. Financial statements include trading account, profit&loss statement, balance sheet, disclosure and cash flow statement
3. The balance amount is called gross profit/loss for the period. If the sales amount is more than the purchases and direct expenses, then the difference is gross profit. However, if the purchases & direct expenses are more than the sales amount, then the difference will be a gross loss. One of the main features is to find out the gross profit/loss made for the year.
4. This balance amount could be either gross profit/loss. This gross profit will be transferred to the credit side of the profit and loss statement. The gross loss will be transferred on the debit side of the profit & loss statement. Gross profit is made when there is an increase in sales or closing stock. Gross loss is incurred when direct expenses and purchases are more than the sales amount.
5. Here, only revenue items will be considered. Capital items will not be recorded. For example, the purchase of machinery for cash is a capital expenditure. This transaction will not be recorded here, instead, it will be recorded in Balance sheet items as an asset. The purchase of goods is a revenue transaction. It will be recorded in this statement.
6. Since this statement is a nominal account, here the transactions are recorded on an accrual basis. It means, that all the transactions that occurred during the period will be recorded irrespective of cash receipt. For example, purchases made but not paid for this year will be recorded as an expense as per the accrual concept
7. Only those transactions that have been taken this year will be recorded. Transactions pertaining to last year or next year will not be recorded in this statement. These transactions are recorded on an Accrual basis but not on a cash basis. One of the features would be recording transactions that have place this financial year.
8. One of the features of the trading account is that it is prepared at the end of the period. Generally, it is prepared after recording transactions in a journal, posting these transactions to the ledger, and extracting ledger balances. The trial balance is prepared from these extracted ledger account balances.
9. The main feature is that it is prepared for trading concerns. Trading concerns are those entities that deal with buying and selling goods & services. It is solely related to buying and selling activity. This is to know the Gross profit/loss incurred for the year from buying and selling activities.
10. Here, only items directly related to trading are recorded. For example, all the purchases, direct expenses, and opening stock are recorded as an expense on the debit side. Sales and closing stock are recorded on the credit side. Similarly, we have closing stock and opening stock. Generally, the closing stock is calculated at cost at the year-end. Closing stock is credited and opening stock is debited. Opening stock will be the closing stock of the last financial year.
what are the objectives (purpose) of preparing Trading Account in accounting?
1. To ascertain Gross Profit or Loss for the period
The main objective or purpose is to know the Gross Profit or Gross Loss made by the trading concerns. It is mainly to know the performance in terms of buying and selling of goods and services throughout the year. This would help in determining the actual sales & purchases made, direct expenses incurred along with the closing\opening stock as well. This helps traders to take useful decisions relating to the purchase or sale of goods and services. Also, it helps to enhance gross profit by increasing sales or reducing direct expenses.
2. To increase Sales and reduce Closing Stock
The main objective is to increase sales or reduce closing stock. This helps to boost sales and gross profit. Also, this helps to minimize the piling up of stock at the year-end. In this way, the closing stock will be lower and sales will be higher. This would enhance gross margin of the business enterprise. This could also be achieved by analysing the last year & current year sales. Offering Discounts to the customers to increase sales. This would result in reduction in closing stock & increase in sales
3. To know the Opening & Closing Stock at the year-end
One of the objectives is to know the stock position at the year-end. Generally, closing stock will be ascertained at the year-end. Opening stock is the closing stock of last year. Closing stock of last year will be carried forward to this year. This will be the opening stock for this year. Opening stock will debited and closing stock to credited in trading account
4. To know the net Purchases or Sales made during the year
One of the objectives is to know the purchases made and sales made during the year. This would help to increase sales. This would also help to increase/decrease purchases based upon circumstances. One ideal way to increase purchases is to increase sales and reduce closing stock. This is done by analysing or comparing sales and purchases with the prior period. This would also help us in managing the sales and purchases.
5. To know Direct Expenses incurred during the year
One of the objectives is to know the direct expenses incurred during the year. Direct expenses are those expenses incurred for the purchase of goods or services. Direct expenses are directly related to the core business operations such as the purchase or sale of goods or services. These expenses form part of the cost of goods sold. Direct expenses include direct labour, wages, packing charges, freight charges, customs duty, carriage inwards, octroi duty
6. To determine the Cost of goods sold
The cost of goods sold is the cost incurred to make the sales. It is the cost of total sales made for any trader. It is determined by deducting closing stock from direct expenses & purchases. All the direct expenses such as direct wages, packing charges, octroi duty, and customs duty form part of cost of goods sold.
Cost of goods sold = (opening stock+purchases+direct expenses) - closing stock
7. To fix the selling price of the product/service
It also helps to fix the selling price of a product or service. This would be achieved by comparison of last year & current year's sales. This can be achieved by analysing sales with the cost of goods sold. This would help to fix the appropriate selling price, boost sales, and increase gross profit. The selling price of a product or service would also depend on other factors such as demand or supply of the goods or services
8. To make decisions relating to Sales & Purchases
It also helps to make useful decisions relating to sales, purchases, and stock management. For example, sales made last year were very low, This year would be an opportunity to increase sales by offering discounts to customers on prompt payment or immediate cash payment. Closing stock will be low when there is an increment in sales. As a result, gross profit would be high.
9. To make trading concerns lucrative & profitable
It also helps to make business enterprises profitable. This can be achieved by analysing sales with the cost of goods sold, by determining appropriate selling prices, offering discounts to customers to increase sales, reducing direct expenses, and making the closing stock very low. This would make the business organisation perform well in their core business operations.
Conclusion
We can conclude that the Trading account in accounting is the first step in preparing final accounts or financial statements. It has useful features and objectives such as stock management and enhanced sales. It is prepared to know the trading activities conducted for any year in the business firm. Also, it is useful to know the gross profit/loss made by a trader during the year.
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