Financial Accounting Concepts

What is the Importance of Trading Account in Final Accounts

We all know that accounting is directed toward keeping systematic records of business transactions.

These records are prepared with a view to ascertaining the results of financial activities by the business enterprise. This result may be either a net profit or a net loss.

Net profit or net loss is ascertained by preparing Profit & Loss A/c. But before calculating net profit, we need to find out the gross profit.

Gross profit is computed by preparing a trading account. A trading account is the summary of principle goods dealt with by the enterprise. Generally, it is the summary of sale and purchase transactions along with opening and closing stocks of the goods.

Format of trading A/c

Trading A/c for the year ending

To Opening Stock XXXX             By Sales       XXXX
To Purchases             XXXX By Closing StockXXXX
To Direct Expenses    XXXX
To Gross Profit c/d to P&L A/c   XXXX XXXX


In a trading firm like a wholesaler, the main business is of buying and selling the same goods. In addition to the amount of the opening stock, all direct expenses will also be debited. For example, freight paid on purchases, octroi, cartage, etc. will all be debited to the Trading Account.

(1) Opening Stock: This item is usually put as the first item on the debit side of the Trading Account. However, in the first year of a business, there will be no opening stock.

(2) Purchases & Purchase Returns: The purchases account always have the debit balance,

showing the gross amount of purchases made. The purchase returns account will have a credit balance showing the return of materials to the suppliers. On the debit side of the trading account, the online amount is shown as indicated (with assumed figures):

To Purchases                        3,00,000

Less: Purchase Returns         (10,000)

Net Purchases                       2,90,000

It may happen sometimes that goods are received but the relevant invoice is not received from the supplier. On the date of the closing of the account, an entry should be passed to debit the purchases account and credit the supplier with the cost of goods.

(3) Carriage & Freight Inwards: Carriage or Freight Inwards should also be debited to the Trading Account, as it is incurred to bring the materials to the firm’s godown and make them available for use. However, if any freight or cartage is paid on any asset, like machinery, it should be added to the cost of the asset and not to be debited to the Trading Account.

(4) Wages: Wages paid to workers in the factory or godowns should be debited to the Trading Account. If any amount is outstanding, it must be brought into books so that full wages for the period concerned are charged to the Trading Account.

However, if wages are paid for the installation of an asset, it should be added to the cost of the asset. Misc. wages paid for part of the profit and loss account.

(5) Sales and Sales Returns: The sales account will always have a credit balance indicating the total sales made during the year. The sales return account will always have a debit balance, showing the total amount of goods returned by customers. The net of the two figures is entered on the credit side of the Trading Account.

(6) Closing Stock and its valuation: Usually there is no account to show the value of goods lying in the godown at the end of the year. However, in order to correctly ascertain the gross profit, the closing stock must be properly taken and valued. Its valuation is done by manually stock-taking at regular intervals or at least once a year.

The entry to be passed is:

Closing Stock Account Dr.

To Trading Account

Alternatively, Closing stock can be adjusted with purchases:

Closing Stock Account Dr.

To Purchases Account

The end product of this entry is to reduce the debit in the Purchases Account. Then, it will appear in the trial balance. In this case, the closing Stock Account is then not entered in the Trading Account and will be shown only in the Balance sheet.

To ascertain the value of the closing stock, it is necessary to make a complete inventory or list of all the items in the godown together with quantities. Damaged or obsolete items are separately listed.

To the list of finished goods, one should also add the goods lying with agents sent to them on a consignment basis and also the goods sent on approval to customers. The valuation principle is the cost or net realizable value whichever is lower.

  1. Goods and Services Tax (GST): Goods and Services Tax is an item of indirect tax. It is collected by the seller from the customers and deposited in Government’s Account as per the Goods and Service Tax Act requirements. Goods and Service Tax is to be deducted from gross sales figures and tax liability (net of payments) is shown as a current liability in the balance sheet.

Illustration 1

From the following information, prepare a Trading Account of M/s. RAJ Traders for the year

Ended 31st December 2012:

Opening Stock  1,00,000
Purchases  6,72,000
Carriage Inwards  30,000
Returns inward1, 00,000
Returns outward72,000
Closing Stock2, 00,000


                                                                In the books of M/s RAJ Traders

Trading A/c for the year ending 31st December 2012

To Opening Stock 100000By Sales        – 110000010,00,000
To Purchases – 672000600000Less: Returns – 100000
Less: Returns – 72000By Closing Stock200,000
To Carriage 30000
To Wages50,000
To Gross Profit c/d to P&L A/c  4,20,000
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