The Difference Between the Trading Account and the Profit & Loss Account

One of the most common points of confusion in SPM Prinsip Perakaunan (SPM code 3756) is the difference between the trading account and the profit and loss account. Both are prepared at the end of the accounting period, both form part of the income statement, and in many textbooks they are written together in one continuous format. Because of this, many students assume they are the same thing.

In fact, each account has its own purpose and contains different items. Once you understand the difference, you can prepare the income statement more accurately and spot misplaced items more easily when answering questions.

What is the trading account?

The trading account is the first part of the income statement for a business that buys and sells goods. Its main purpose is to determine the gross profit or gross loss for the period.

Gross profit is calculated by subtracting the cost of goods sold from net sales. The cost of goods sold is found from opening stock plus net purchases and direct costs, less closing stock. In short, the trading account answers one question only: how much profit was made from the activity of buying and selling goods, before taking into account other operating expenses?

What is the profit and loss account?

The profit and loss account is the second part, continuing directly after the trading account. It begins with the gross profit that has been brought down from the trading account.

The purpose of the profit and loss account is to determine the net profit or net loss. Here we add other revenue besides sales (such as discount received, commission received, rent received and interest received), then subtract all operating expenses such as salaries, rent, insurance, depreciation, bad debts and discount allowed. The final balance is the net profit, which belongs to the owner of the business.

The main differences

The most fundamental difference is the end result. The trading account produces gross profit, while the profit and loss account produces net profit. Gross profit is always calculated first, because that figure becomes the starting point for the profit and loss account.

The second difference is the type of items. The trading account contains only items directly related to trading goods: sales, sales returns, opening stock, purchases, purchase returns, carriage inwards and direct costs. The profit and loss account, by contrast, contains other revenue and operating expenses that are not directly involved in acquiring goods.

The third difference is scope. The trading account measures the performance of buying and selling activity only, whereas the profit and loss account measures the overall performance of the business after taking into account all the costs of running its operations.

Items in the trading account

On the debit side of the trading account, we record opening stock, purchases (less purchase returns), carriage inwards and direct costs such as duty on purchases and, for certain businesses, production wages. On the credit side, we record sales (less sales returns) and closing stock.

Remember: carriage inwards is included in the trading account because it is part of the cost of acquiring goods. Many students wrongly place it in the profit and loss account. Closing stock, meanwhile, is always subtracted in the calculation of cost of goods sold, never added.

Items in the profit and loss account

The profit and loss account begins with gross profit on the credit side. Then we add other revenue such as discount received, commission received, rent received and interest received.

On the debit side, we record all operating expenses: administrative salaries and wages, rent of premises, utility bills, insurance, advertising, carriage outwards, depreciation of assets, bad debts and discount allowed. Note that carriage outwards is placed here because it is the cost of delivering goods to customers, not the cost of acquiring goods.

How to calculate gross profit and net profit

Step one: calculate net sales (sales less sales returns) and net purchases (purchases less purchase returns). Step two: calculate cost of goods sold using the formula opening stock plus net purchases plus carriage inwards less closing stock. Step three: gross profit equals net sales less cost of goods sold. At this point you have completed the trading account.

Step four: bring down the gross profit into the profit and loss account, add all other revenue, then subtract all operating expenses. The remaining balance is net profit. If expenses exceed revenue, the result is a net loss.

Common student mistakes

The first mistake is mixing up items, for example placing discount received in the trading account, or placing carriage inwards in the profit and loss account. Remember the simple principle: costs directly related to acquiring goods go into the trading account; everything else goes into the profit and loss account.

The second mistake is forgetting to adjust closing stock or mishandling adjustments such as accrued expenses and revenue received in advance. The third mistake is not transferring gross profit correctly into the profit and loss account. Repeated practice with a variety of question types is the best way to overcome these errors.

How we help

In our online 1-to-1 lessons, an experienced teacher can focus on whatever confuses you, such as telling the trading account apart from the profit and loss account.

Rates start from RM50 an hour, and you can begin with a paid one-hour trial lesson at the teacher's rate.

FAQ

Are the trading account and the profit and loss account written separately? In common practice they are written together as one continuous income statement, but their purposes and items remain different.

Can a business have a gross profit but a net loss? Yes. If the gross profit is not enough to cover all operating expenses, the business can record a net loss even though its buying and selling activity was profitable.

Do you offer group sessions or packages? No. We only offer one-to-one lessons, and we do not help with coursework or school assignments.