Closing Entries to Prepare Trading Account

With the completion of an accounting period comes the important activity of preparing the financial statements. The first thing one does in doing this, particularly for those dealing in goods or commodities of buy and sell type, is preparing the Trading Account. It facilitates the establishment of the Gross Profit or Gross Loss arising out of the central business of trading activities. To actually show this properly, we are required to make closing entries.

What are closing entries?

Closing entries are used to close temporary accounts like revenues and expenses at the end of an accounting period.

This involves transferring the balances from these temporary accounts to a summary account, which will then be used to determine the gross profit. Before preparing the Trading account, various accounts need to be closed and transferred to the trading account at the end of the accounting period.

Real accounts are transferred to the balance sheet and nominal account’s balances are transferred either to Profit and Loss A/c or Trading account.

We need to pass some journal entries to transfer these balances. These entries are called closing entries.

The following closing entries will be required to be passed in respect of the trading account:

For opening stock

Trading A/c Dr

To Opening Stock

For purchases returns:

Returns Outward A/c    Dr

To Purchases Account

For returns inward:

Sales A/c                    Dr

To Returns Inwards Account

(Account information is generally given both in respect of gross sales, and purchases and the respective returns)

For purchases account:

Trading A/c               Dr

To Purchases A/c

(The amount being the net amount after returns)

For expenses

Trading A/c               Dr

To Expenses

(Account and credit the respective expenses accounts individually)

For transfer of sales

Sales A/c                                Dr

To Trading Account

For closing stock

Stock A/c                                Dr

To Trading A/c

(The Stock Account will be carried forward to the next year)

Entries mentioned above, the other entries are usually summarised as follows

(1)       Trading Account Dr.

To Opening Stock Account

To Purchases Account

To Wages Account

To Freight on Purchases Account, etc.

(2)       Sales Account Dr.

Closing Stock Account Dr.

To Trading Account

At this stage, the Trading Account will reveal the gross profit if the credit side is greater or gross loss if the credit side is lesser. The gross profit will be transferred to the Profit and Loss Account by the Entry:

Trading Account Dr.

To Profit and Loss Account

The entry for gross loss, if there be any is:

Profit and Loss Account Dr.

To Trading Account

Illustration 2

From the information pass necessary closing entries in the journal proper Of M/s. XYZ Traders.

($)

Opening Stock                        100,000

Purchases                                672,000

Carriage Inwards                     30,000

Wages                                     50,000

Sales                                        1,100,000

Returns inward                        100,000

Returns outward                      72,000

Closing stock                           200,000

Solution

DATE	PARTICULARS		L.F.	Dr ($)	Cr ($)
2012
Dec 31	Return outward A/c	Dr		72,000
	To Purchases A/c				72000
	(Being the transfer of goods returned)
,,	Sales A/c	Dr.		100000
	To Return Inward A/c				100000
	(Being the transfer of returns to sales)
“	Sales A/c	Dr.		1000000
	To Trading A/c				1000000
	(Being transfer of the balance of sales to Trading A/c)
“	Trading A/c	Dr.		780000
	To Opening Stock				100000
	To Purchases A/c				600000
	To Wages A/c				50000
	To Carriage Inwards A/c				30000
	(Being transfer of opening balances)
,,	Closing Stock A/c	Dr.		200000
	To Trading A/c				200000
	(Being closing stock transferred to Trading A/c)
“	Trading A/c	Dr.		420000
	To Gross Profit				420000
	(Being the amount of gross profit)
“	Gross Profit	Dr.		420000
	To Profit and Loss A/c				420000
	(Being the transfer of gross profit to Profit and Loss A/c)

Conclusion

Closing entries are a critical part of the accounting cycle. For trading businesses, they are crucial for properly preparing the Trading Account and knowing the profitability of their main operations. By methodically shifting the balances of pertinent temporary accounts, businesses are able to gain useful information regarding their gross profit margins and make sound decisions.